Bollinger Band Strategy Study (Part 1)

Last week, I proposed an idea to Nick about a strategy that trades the US30, a highly leveraged index that can generate immense gains as well as immense losses. In a time of high volatility, it's hard to keep your trades in something that moves heavily on an already highly leveraged chart. If you have ever traded the US30 as well as other US indices like SPX500 or NAS100, you have probably seen how large they show gains/losses in even the smallest of moves. But if you guess right, some of these trades can work out big for you. One of our members followed a short signal on US30 in the group and made over $100 on a .01 lot in a matter of 1-2 hours. This is because these indices trade up to only two decimal places (the hundredths place) on the index where as an average currency pair like EUR/USD trades up to five decimal places. There are many pips moving in each cent that the index moves, which means lots of pips go up or down on even the smallest lot size. With such a high leverage, I wanted to find a way to take advantage of these moves.

The Strategy

The strategy is fairly simple: We're going to look at bollinger bands to understand the 14-day average volatility by looking at the distance between the upper and lower bollinger bands. With that in mind, trades will be taken every time the price hits the lower band or upper band, and will look to close when the price hits in the middle of the bands. It will also take a short position on the top of the bands and won't close until it hits the center of the band.

This chart is basically what each trade would look like. As you can see, there have been a lot more winners than losers on this period of time. However, within this period, especially the last short taken, you can be stuck in these trades for days or weeks depending on where the prices move. Notice how all the trades close in the middle of the bands. All trades are taken either on the top band or the bottom band, and all closes are in the middle. Although some of these trades look short with little movement, that is exactly why I chose the US30. The first demo trade on that chart is about a 2.87% gain on the trade, which is good on any currency pair. But on the US30, that kind of trade is great.

For this study, at least in phase one, we don't want to include any other indicators. RSI doesn't matter, support and resistance doesn't matter, fibs and moving averages don't matter, etc. Here is a raw study of the strategy to see how it will do on its own. After finding more results, we will be likely to tweak some things. We might even trash the whole idea, but not after some careful study and testing.

The Risk Management

Earlier in the article, I said we would use the bollinger bands to measure volatility and trade off that gauge. To better understand what I'm getting at, let's say that the distance between the top and bottom bands are 4% apart; so a 4% move in price from the bottom band will take you to the top band. That is now considered our gauge that we will trade in.

But what happens when the bands inevitably expand or contract? That is where our risk management comes into play. If the distance were to double, the strategy shuts off and will not look for trades to enter until the 14-day range has stabilized. So, if the US30 became more volatile and the 4% distance turned into an 8% distance, the bot will shut off and the open trade(s) will close.

This is meant to protect us from horrible sell offs like this one in March during the economic shutdown. Now, let's say that the bands move from 4% apart to 8% apart, and for 14 days, the bands have been maintaining their distance at 8% apart. If that happens, the bot will turn back on and use the 8% range (give or take 2%) as its new gauge. Not only will we have a shut off switch during periods of high volatility, but stop losses placed for every trade. I'd like to see if this is more profitable with or without stop losses placed. The SLs will be placed 1.5 times the distance between the center and the top of the bollinger bands at the time the trade is taken. These are fixed positions that will not adjust to future price action. Whatever the distance between the red center line and the upper or lower boundary is at the time of the executed trade, the stop loss will be 1.5X the distance.

Hopefully, this picture will make things clearer. At this particular time, the center of the two bands is 2.7% away from the bottom band. Because this is a buy entry, the stop loss will be below the entry at 1.5X the distance which is 4.05% away from the center. If I took a short, and the distance from the center to the top was 2.7%, the stop loss would be 4.05% from the center to the stop loss.

Next Steps

This idea is, as of now, in it's very early stages of development. We haven't decided to make this an automated trading bot or a scanner with long and short alerts including the recommended stop losses. Obviously, I'm expecting to see lots of holes in the strategy, but that's all part of the process. I have never published my trading strategies while they're in the process of being developed, so this is a first for me. However, I am really excited to see what will come out of it. What will be wrong with it? What should be added and what should be taken out? Will certain time frames work better than others? The next steps will include more research and backtesting, as well as more questions, to show what this idea will look like if we were to trade the US30's past to profit in the future.
I will update this with a part two once we've done more research.

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Please note that this email is my personal opinion only. I am not a licensed financial advisor, and any information shared or discussed is not to be construed as investment advice. Trading and investing involves a degree of risk, and is not suitable to all investors. Please consult with your financial advisor before making any sort of investment decisions.

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