Writer:Neko Trader
Debuted in FX in 2012. Since then, performance has been in a gentle downtrend... and in 2015, somehow posted a lifetime profit! A short-term technical trader who dreams of full-time trading.
Blog:Come to the FX Trader's Grove

Hello everyone, I’m Neko Trader. (´・ω・｀) Hi

Last time I discussed a contrarian method using the properties of the Bollinger Bands,somehow it felt a bit questionable...and wrote about that.

I’ll link to past articles on the blog, so feel free to drop by.

This time, the slightly questionable reason,the pitfalls hidden in Bollinger Bands and,the other property of Bollinger BandsI’m going to write about.

The Pitfalls of Bollinger Bands

To put it bluntly, it is thatthe market is not normally distributed.

Gaaaah!!!

In reality, the rates near the mean (moving average) are fewer than a normal distribution would predict, and rates that deviate from it are more numerous than a normal distribution would predict,

and this distribution looks as if it has been crushed by a normal distribution.

Normal distribution (dashed line) and actual distribution image

John, when developing Bollinger Bands, conducted extensive validation to determine what is most appropriate for measuring volatility.

Ah, who is JohnJohn Bollinger, the father of Bollinger Bands.

As a result of that validation, standard deviation σ was adopted, but the market itself is not normally distributed

...feels somewhat contradictory.

John also says this.

「Even if a cross with the band is confirmed, it does not directly serve as a basis for trading signals aimed at mean reversion.(｀・ω・´) Bow!」

John’s Hard-Earned Fruits: Squeezes and Expansions

“Okay, John! So how should Bollinger Bands be used?!”

Then, a straightforward question arises.

The biggest feature of Bollinger Bands is measuring volatility,John’s rigorous testingalso makes that clear.

Volatility is not forever high or low; it rises and falls, you’ll understand,

and what visually confirms those high and low states isthe Bollinger BandandSqueezeandExpansion

For this visual clarity, I have long loved Bollinger Bands.

Dollar/Yen hourly chart

is now a familiar hourly chart of USD/JPY.

In the boxed area, the ±σ to ±3σ lines of Bollinger Bands are contracting and moving sideways.

This is called a squeeze; low volatility, and the longer the period of narrow band width, the stronger the state of volatility decline.

Conversely, the band expanding, shown after the boxed area, is called expansion, and you can see volatility expanding as the band width widens.

What’s important here is

After a squeezeExpansion occurs

After an expansionSqueeze occurs

that is, it appears accordingly.

Volatility’s Rule: The Burst of Trends

Typically, in an uptrend there are many new longs and many shorts setting stops, causing volatility to rise. (Expansion)

Of course, it does not continue forever; at some point the power balance between longs and shorts balances out, the trend calms and volatility decreases. (Squeeze)

And someday that energy explodes, spawning a new trend. Reading the cycle of band contraction/expansion and range/trend is, in my view, Bollinger Bands’ greatest edge.

Now, next time I’ll consider the fever time, which I also love, that appears during band expansions.

Well then, everyone, may you have explosive profits today as well! (σ・∀・)σ Gotts!!