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The Bollinger Band Mean Reversal Forex Trading Strategy
The Bollinger Band Mean Reversal Forex Trading Strategy
There are 2 elements that drive profitable trading. The first is how often the trader wins and the second is the reward-risk ratio related to trades. Everything else is irrelevant, unless the trader has a good combination of these 2 elements.
Some traders do not like to take a loss at all and prefer to have an excellent win rate, they are happy to have a lower reward to risk ratio on the basis that they will win more than they lose.
On the contrary, another type of trader will only trade when there is a high reward-risk ratio. The aim is to generate high profits on one trade rather than focusing on win rate.
Traders working on high win rate frequently acquire small wins consistently allowing them to benefit from the Forex market. These traders are not prepared to risk taking a large loss and close the trade early for a smaller loss.
On the other end of the spectrum, traders with a high reward-risk strategy have less wins, but when they do win, the profit is big enough to cover the loss and takes them into the red.
The different trading styles are most obvious with traders of mean reversal than traders of a trend reversal. Traders of mean reversal aim for small wins often. This allows for the price to return to its mean.
Oppositely, traders of trend reversal trade as the market reverses. Traders use different techniques to identify the reversal, such as: moving average crossovers and price action reversal. Not unusually traders regularly get it wrong, but when they do get it right, they win big.
Traders can get good results using the Bollinger Band Mean Reversal Forex Trading Strategy as a mean reversal theory, but the need for consistency is paramount.
The foundation of this custom technical indicator is moving averages and Bollinger Bands. It is similar to Bollinger Bands and is plotted on the price chart. The midline is based on the moving average, and similarly to Bollinger bands the outer lines show the standard deviation from the mean. The behavior of the midline differs to Bollinger Bands as it is a modified moving average. The trader can also shift it left or right.
We can exploit this indicator for several things. Based on the moving average line, it can be a trend indicator.
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Based on the slope of the moving average traders can determine the direction of the trend. Momentum could also be detected. To detect momentum, we look for obvious momentum candles closing outside of the outer bands, with another candle following in the same direction.
Volatility can also be detected. Expanding MA BBands could indicate increased volatility, while tighter bands could indicate market contraction. Finally, we can use it to find potential setups for mean reversal. When a candle touches a band and is rejected, it could imply a mean reversal.
This classical technical indicator is very popular with traders. Used mainly to identify momentum by comparing a closing price to a range of prices over a certain time period. This is a trusted and successful technical indicator.
In a separate window to the price chart, the stochastic oscillator is displayed by 2 plotted lines, the solid line is the faster of the 2, with the slower line being dashed. There is a range of 0-100. Oversold/overbought conditions together with trend could be identified with the stochastic oscillator.
A bullish trend is expected when the faster line is above the slower line, whereas when the faster line is below the slower line, we can assume a bearish trend.
To indicate a market condition that is oversold, we would see both lines above 80 and both lines below 20 would assume the market is oversold.
One effective thing to notice is when the 2 line crossover when prices are overbought or oversold. When this convergence occurs, it is assumed a reversal is occurring on either an overbought or oversold market.
Reliant on overbought/oversold conditions indicated by the MA BBands and stochastic oscillator, trade signals are based upon the convergence of these conditions and the reversal price action pattern.
Crudely based on the candles touching the outer bands, market price considered overbought or oversold will be identified by the MA BBands.
Established by the lines dropping below 20 or climbing above 80, the stochastic Oscillator establishes when the price is overbought or oversold.
Should the 2 overbought or oversold conditions converge, the chart should be observed for possible signs of trend reversal based on candlestick reversal patterns.
Setup for a buy trade
- On the MA BBands indicator, candles should be touching the lower of the 2 outer bands.
- Lines shown on the Stochastic oscillator chart should be below 20.
- A visible bullish reversal pattern of the candlesticks should be witnessed.
- On the agreement of all of the above conditions, a buy trade should be made.
- A stop loss should be placed on the fractal below the entry candle.
- Once the solid line on the stochastic oscillator crosses below the dashed line, the trade should be closed.
Setup for a sell trade
- On the MA BBands indicator, candles should be touching the higher of the outer 2 bands.
- Lines on the Stochastic Oscillator chart should be above 80.
- A visible bearish reversal pattern of the Forex candlesticks should be witnessed.
- On the agreement of all the above conditions, a sell trade should be made.
- A stop loss should be placed on the fractal above the entry candle.
- Once the solid line crosses above the dashed line on the stochastic oscillator, the trade should be closed.