Bollinger Bands Break Out System

Bollinger bands

The Bollinger bands were created by John Bollinger in the early 1980s. Basically the Bollinger bands consist of three curves: o The first one (intermediate band) is a simple moving average that is used as the base for the upper and lower and to define the dominating trend. o The second and third are the upper and lower bands; typically n times the standard deviation of the sample taken for the average up and n samples down.

The purpose of these 3 lines is to provide a channel to measure the volatility in a dynamic way and at the same time they serve as a relative short term reference for high and low price within the quotation. The most common configuration and the one used in this thesis are 25 periods for the sample size and 2 standard deviations up and down from the moving average. Although the Bollinger bands are not considered indicators for buying and selling signals in theory, they can be used to detect the beginning of a strong trend up or down and they can be the base for a trend following system.

Based on the rules given in the book ³Trading Systems and Methods´ by Perry J. Kaufman, a system has been developed to make use of the buying and selling signals that can be derived from the movements of the price in relation to the Bollinger bands. 

 

Buy signal (entry long): price penetration (close above) the upper line. Sell signal (entry short): price penetration of the lower line (close below the line). Position close: when the price penetrates back the middle line.

Therefore the system always has a stop loss or a risk of losing the difference between the upper line and the middle line, that is 2 times the standard deviation which depending on the volatility of the market can be higher or lower but in any case, it represents a low percentage. Tests performed:

The system has been tested on the Dow Jones Industrial Average index (DJI), on the Future Ibex35 (MFXI), in the Dax performance Index (DAX) and in the S&P500; with historical data from the 1 January of 2000 up to the 31 December of 2009. It is a system with a long reaction time, it does not anticipate the coming trend but it rather enters in it when it has already started and gone out of the bands losing the initial benefits. It has to take advantage of an already initiated strong trend and follow it until the trend is finished. It has a high amount of false signals because the prices can penetrate the upper or lower band
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75 % S&P500 74 -0.09 % DAX 74 +0. On the other hand.1 % -29.076 % -5.73 % -35. the results are not enough satisfactory as it can be seen in the following summary table: (1 day bar time) Number of trades Average profit per trade Net Profit Worst Loss series DJI 75 -0.21 % -29. the movement (either up or down) is almost not enough long to pay back the false signals. even if there is a trend after the band penetration. the number of false signal is increased significantly because during the day there are many highs and lows quite far from the average and the standard deviation.096 % +7. without a following trend. the system is only profitable for the Ibex35 and the Dax indexes but losing all the profitability on the other 2 markets. Even with 1 day bars.75 % During the 10 years of back testing. Moreover. this low ratio of profitable operations is balanced by the fact that the positive operations are bigger than the negative operations. Example of its behavior can be seen in the picture below: Future of Ibex35 on 5 day bars from the year 2000 to 2009 As it can be seen.11 % MFXI 67 +0. the results are quite different and more profitable. the system generates false entry signals with negative results. on the other hand. When the system is tested on an intraday basis (bars of less than 1 day duration). . as soon as the market does not have a strong trend (like in the right part of the chart). when the system is tested on 5 days bars.436 % +29.18 % -42.475 % -35. During a strong trend on the other hand the signals are almost always good and with a considerable profit.without starting a long trend.

.35 % S&P500 10 +4.6 % -26.30 % -11.13 % +41. Many software package offer the possibility to optimize parameters such as the standard deviation ratio (in this case it has been fixed on n=2.27 % -9.47 % -6.98 % +109.90 % +62.79 % -7. the penetration has to be confirmed by a second bar out of the Bollinger bands.39 % -28.45 % Although the results are now profitable from a mathematical point of view. therefore those parameters have not been optimized for these calculations as it can be considered as curve fitting. a new condition will be added to the system:  Instead of a single penetration to the lower or the upper band. not significant for a future better behavior.79 % -6. only on the DAX the results are slightly lower because the modification has affected false and good entries in the same way.49 % With this modification. In order to reduce the amount of false signals. the system has improved its behavior in 3 of the 4 indexes.98 % S&P500 13 +3.52 % DAX 7 +8.(5 day bar time) Number of trades Average profit per trade Net Profit Worst Loss series DJI 14 -0. With this new condition.32 % +43.22 % -17. now in order to open a new position. upper line 2 standard deviations up and lower band 2 standard deviations down the moving average Or even the position of other ). intermediate exit bands.59 % DAX 10 +10.39 % +3.08 % +60. it can be improved by reducing the amount of false signals. the system will be a little bit slower entering into the trend but the amount of false signals will be significantly reduced as it can be seen in the following table: (5 day bar time) Number of trades Average profit per trade Net Profit Worst Loss series DJI 10 +0.60 % +50.08 % MFXI 10 +6.9 % -23. And indeed it can improve slightly the results on some markets but it affects negatively others.12 % MFXI 14 +3.

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