Dealing with the Squeeze
Dealing with the Squeeze
In each one of my weekly articles, I hope to share glimpses of my trading experiences with you in an effort to point traders of all skill levels in the right direction for consistency in their speculative activities. Having now written these articles for around a year, I have talked about a wide variety of aspects of the Forex Trading environment, but I must admit that when I first agreed to write these weekly updates, I was a little concerned about running out of material to talk about! My trading is simple in nature and as my career has lengthened in duration, my own perspective of consistently profitable trading has become more logic-based and "black and white" in nature. However, there is a uniquely paradoxical aspect to this simplicity as well, in that this simplicity does not equate to meaning that trading is easy as a result. With this dynamic ever present, I have found myself not quite so challenged in my writing duties as I first thought.
You see before jumping into the market head first, any trader should respect the fundamental principle that trading is simple, but far from easy. Is this due to its technical aspects? Or maybe it is because of the depth of fundamental factors associated with the market in general? Could it possibly be because market makers and institutions are always looking to wipe out the little guy? Well friends, I believe that all of the aforementioned are nothing to do with true challenges faced by the speculative trader at all. Rather, I understand that the vast majority of hurdles encountered by the novice and experienced traders alike, are mainly due to problems with their own perception of trading and the markets. These perceptions are often generated by a lack of initial market experience, which is an easy fix as one spends more and more time in the market and witnesses events for themselves first-hand. But on the other hand, we also need to be cautious of the abundance of "trading know-how" and educational supplements out there on the internet and in the written text.
For the purpose of this week's topic, I would like to talk about one of the most popular and respected technical indicators of all: Bollinger Bands. As you may or may not know, Bollinger Bands were developed and invented by the market technician John Bollinger in the 1980's. Taking the simple idea of the Moving Average, he then took this one step further by plotting a moving average on the chart as a "center line" of sorts, which represented the average price of the asset being charted. He then calculated and applied two separate lines above and below the center moving average. These lines were formulated as a measure of volatility by showing the trader these Bollinger Bands as +2 and -2 standard deviations from the center line. It's not as complicated as you may think in essence, especially when you think of the two lines as a measure of volatility from the asset's true value. Imagine the bands as simply an illustration of the currency pair's average trading range, with the upper and lower bands representing potential support and resistance as shown below:
On this Daily chart of USDCAD, we can clearly see how the Bollinger Bands have contained the price as the market continually exhibited a range bound characteristic. On the chart, the grey line is the moving average center line which represents the average price, with the upper blue and lower red bands acting as price support and resistance, with settings of +2 and -2 standard deviations as their respective setting inputs. If used correctly and in a structured manner, the Bollinger Bands can be a highly effective tool for the disciplined trader when used to gauge extensions in price action and when we are in major supply and demand extremes. However, they can also be used in another widely discussed manner which looks for "squeezes" in the bands.
Known as the "Bollinger Squeeze," this technique has been adopted by the breakout style of traders and involves findings market situations where the bands narrow tightly around the candles, signaling a contraction or indecision in the price. These periods of consolidation often lead to a breakout in price as many already know. While this strategy can be useful to the well planned and disciplined trader, we should also remember that the very best indicator above all is price itself. Let's take a look at the example below:
On the chart above, I have highlighted two examples of the squeeze with purple arrows and yellow boxes. At these points in time, the GBPUSD entered very tight trading ranges as it primed itself for the next big move. Either a break of the range highs or a break of the range lows would signal the breakout trader to enter the market. In the first example on 8/27, we broke to the downside with momentum, yet the market quickly snapped back again to put in a new high before then continuing lower. Yes, you could have made money on the short side, but there was a very good chance of a stop out from the rally which followed the break lower, a common scenario faced when taking breaks. In the second example on 8/31, we have a much cleaner break lower after another Bollinger Squeeze and this time, the signal is good as the market breaks lower and continued a steady downside descent. If the proper execution and trade management is employed, then the breakout trader could have made some decent pips with the squeeze technique without question.
However, it should also be noted that by following and understanding the simple dynamics of support and resistance, the Bollinger Bands presented some even better opportunities to take. I have marked three areas of resistance and two areas of support, which all coincided with tests of either the upper or lower bands, and of which all gave generous risk-to-reward profit margins to boot. When used as a filtering tool, the bands make a powerful compliment to static price levels and are an objective way to spot and deal with true extremes in price. I am not a breakout trader and I never have been, not because I think it is less effective than buying low and selling high, but rather because it does not fit my personal style of approaching the market. In my experience, I have found that I am more comfortable with larger risk-to-reward ratios, as opposed to hit rates, and my trading approach suits this well. Whatever style is comfortable for you is really the right one, but if you do look to indulge in the odd Bollinger Squeeze from time-to-time, then just make sure it doesn't end up squeezing your account too tightly in the process. I hope this helped.
Be well and take care,
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