What is bollinger band squeeze

Keltner Channels are the second component and they are similar to Bollinger Bands in their appearance and usage. Similar to Bollinger Bands, the Keltner Channel can be used in both breakout and fading strategies. Typically the channel lines are drawn 1. An advantage of the Keltner Channel over Bollinger Bands is that it reacts more quickly to price moves, and as trends develop the channels begin sloping up or down with little lag.

Whenever market volatility decreases and our strong trends begin to slow, we see the Bollinger Bands tighten while the Keltner Channel remains relatively constan t. As volatility continues to decrease the bands will eventually move inside the channel lines and this is where we become on alert for trading signals.

Note that during these periods, price chops around in a narrow range until a breakout movement eventually ends the squeeze. If you are a day trader presented with this information you may decide to sit on the sidelines until the squeeze is over as the bands show you are in a choppy market. Traders may want to watch support and resistance levels when the squeeze is showing signs of ending. Many traders like to play the breakout expecting that the coiled energy in the squeeze will lead to large price movements.

Using the default values for the indicators 2 standard deviations, 1. I have to remind you again; there is no such thing as the holy grail of trading.

For further confirmation, look for volume to build on up days. On the other hand, if price is moving higher but the indicators are showing negative divergence, look for a downside breakout—especially if there have been increasing volume spikes on down days. Another indication of breakout direction is the way the bands move on expansion. When a powerful trend is born, the resulting explosive volatility increase is often so great that the lower band will turn downward in an upside break, or the upper band will turn higher in a downside breakout.

Bandwidth reaches a minimum distance apart in May indicated by the blue arrow in window 2 , followed by an explosive breakout to the upside. Note the volume build that occurred beginning in mid-April through July. Traders who act quickly on the breakout get caught offside, which can prove extremely costly if they do not use stop-losses.

Those expecting the head fake can quickly cover their original position and enter a trade in the direction of the reversal. In Figure 2, Amazon appeared to be giving a Squeeze setup in early February. A Squeeze candidate is identified when the bandwidth is at a six-month low value. Breaking above the day moving average the orange line in the lower volume window on drops in stock price, suggesting a build-up in selling pressure, volume shows above normal values on downside price moves.

Finally, the long-term trendline is breached to the downside in the first week of February. A downside breakout would be confirmed by a penetration in the long-term support line line 5 of window III and a continued increase in volume on downside moves. The challenge lies in the fact that the stock had demonstrated a strong uptrend , and one pillar of technical analysis is that the dominant trend will continue until an equal or greater force operates in the opposite direction.

This means the stock could very well make a head fake down through the trendline , then immediately reverse and break out to the upside. It could also fake out to the upside and break down. While it looks set to break out to the downside along with a trend reversal, one must await confirmation that a trend reversal has taken place and, in case there is a fake-out, be ready to change trade direction at a moment's notice.

Just like any other strategy, the Bollinger Squeeze shouldn't be the be-all and end-all of your trading career. Remember, like everything else in the investment world, it does have its limitations. After a period of consolidation, the price often makes a larger move in either direction, ideally on high volume.

Expanding volume on a breakout is a sign that traders are voting with their money that the price will continue to move in the breakout direction.

When the price breaks through the upper or lower band, the trader buys or sells the asset, respectively. A stop-loss order is traditionally placed outside the consolidation on the opposite side of the breakout. Here is a brief look at the differences, so you can decide which one you like better.

One technical indicator is not better than the other; it is a personal choice based on which works best for the strategies being employed.

Traders can also add multiple bands, which helps highlight the strength of price moves. Another way to use the bands is to look for volatility contractions. These contractions are typically followed by significant price breakouts, ideally on large volume. While the two indicators are similar, they are not exactly alike.

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Your Practice. The Bollinger band is a volatility based band wherein the upper and lower bands are constructed using the 20 day simple moving average line, and has a default setting of two standard deviations on either side of the centerline. One of the most noticeable characteristics of the Bollinger band is that the majority of the price action will be contained within the upper and lower boundaries.

The bands will expand and contract based on the recent market activity. There are two variations of the squeeze set up. The first uses the Bollinger band width indicator alongside the standard Bollinger band study, and the second variation uses the Keltner channel. We will be discussing each of these variations and illustrate a few trade examples as we progress further along.

Regardless of the method used to trade the squeeze set up, the ultimate goal is the same. That is to say that we need some mechanism by which we would define a consolidation, and a process for validating a breakout from that consolidation that is most likely to lead to an impulsive price move following the breakout. We need to try to achieve this, while at the same time, reducing the chance of fakeouts. We can gain a deeper appreciation of the Bollinger squeeze trading set up once we take some time to understand the importance of volatility in the markets.

Volatility is considered to be mean reverting within the financial markets. This is to say that there is a distinct ebb and flow in the markets. Prices move from periods of relative quiet, or low volatility, to periods of relative excitement, or high volatility. This is a cyclical process and is ever present.

Traders who understand this characteristic can use that knowledge to gain an edge in their trading. The tendency for the markets to move through this cycle of expansion and contraction is much more predictable, then the actual directionality of market moves.

Essentially, it is very difficult to predict where prices are going next. On the other hand, predicting volatility cycles can prove to be a much more fruitful effort. If we think about this from the intuitive level, we can understand why a Bollinger volatility breakout would make sense.

We know that markets do not move in one direction forever. Instead there will be periods wherein the markets trend, followed by periods wherein the markets move sideways. The order flow is constantly moving from areas of balance or price equilibrium to periods of imbalance or trend moves.

This phenomenon is present regardless of your chosen trading timeframe. This ebb and flow occurs at the very smallest timeframe to the very longest time frame as well. This is because the markets are fractal in nature and as such the self-repeating patterns of market volatility will occur at all degrees of trend. The Bollinger band squeeze set up that is the purpose of this lesson is just one of a myriad of ways that a trader can take advantage of the volatility contraction and expansion footprints that are ever present on the price charts.

Some other technical methods that also seek to drive profits using a volatility-based model include narrow range bars , opening range breakout, options implied volatility analysis, and VIX analysis.

Notice on the chart below how periods of low volatility are followed by periods of high volatility. Bollinger bands were created by John Bollinger , a well-known commodity trading advisor. The primary benefit of using Bollinger bands is that it helps in evaluating the overall volatility within a specific market. The Bollinger band is comprised of three lines. The central line is a simple moving average line with a 20 period lookback.

The upper line of the Bollinger band is computed as being two standard deviations above the central SMA line. And similarly, the lower line of the Bollinger band is calculated as two standard deviations below the central SMA line. One of the important characteristics of Bollinger bands is that as markets become more volatile the bands will tend to widen.