Using Bollinger Bands to detect a period of low volatility that moves to higher volatility, this system attempts to capture the resulting trend. This system is called Method 1 or the Volatility Breakout System in John Bollinger's book, Bollinger on Bollinger Bands.
Measure the volatility using the BandWidth indicator and find when it has hit a six month low. After this period of low volatility, enter when the price touches and breaks out of one of the bands. The goal with this system is to catch when a trend begins by breaking out and following the band. If the price breaks through the upper band, enter a long position and continue with the position as the price goes up with the upper band following. If the price breaks through the lower band, enter a short position and continue with the position as the price goes down with the lower band following. If the price touches a band and head fakes to the other band, you'll get a whipsaw and need to enter the new direction. As the price goes in your favor, you can pyramid additional positions to increase profits while moving the stop closer with any pyramiding.
While John doesn't mention details on Position Sizing in his book, we'll add the Percent Volatility Position Sizing to the system. Calculate the value of the price difference of the entry to the stop. Calculate the amount of risk per trade or percentage of your equity you want to put on the line if the trade goes against you (2% or less in most cases). Divide the amount to be risked by the value of the movement to the stop, round down to a whole amount available for a position and you'll have your position size. With this position sizing, you limit your risk if the trade goes against you so you can cut your losses short and let your profits run. For a forex example we'll use a long EUR/USD position at 1.3203 with a 10 day ATR of 0.0114 that has a tick or pip size of 0.0001 and each pip or tick is $1. If we have a $100,000 account and we are willing to risk 2%, we only want $2,000 on the line. We take our $2,000 and divide it by our 228 ticks of movement (10 day ATR * 2) until our stop since it is worth $1 for each tick. $2,000 ÷ $228 ends up being 8.77 lots that we will round down to 8 lots. That is our position size to limit our risk to less than 2% of our trading equity while still allowing room for the price to move in its range.
The initial stop should be the opposite band or if that is outside the daily range, use a multiple of ATR such as 2 * 10 day ATR.
Parabolic SAR would follow the price and exit quicker or to keep from exiting too early, exit when the price reaches the middle moving average, the opposite band or between the two. As the price movement slows at the end of the trend, the bands will tighten and a tag of the opposite band may not give back too much profit but also not exit the position before the trend is over.
In the case of a headfake or whipsaw at the beginning, have criteria that allows for reentry as the trend continues even if it follows the opposite band that it initially crosses. Depending on your timeframe and the desired volatility levels, you can use the standard Bollinger Band parameters of 2 standard deviations of a 20 period average or you can use a 1.5 standard deviation with a 15 period average.
Review John Bollinger's words on the Volatility Breakout System in his book, Bollinger on Bollinger Bands. The system is also found at John's site including his views on dealing with the head fake and finding out that Bruce Babcock had this trading approach as one of his favorites.
Automate and test this Bollinger Band Volatility Breakout system using MetaTrader 4 code found at www.TFmt4.com. Test and find the best variables for profitability. Make changes to the system to find the best settings for your Forex trading style and risk tolerance.
Automate and test this Bollinger Band Volatility Breakout system using MetaTrader 5 code found at www.TFmt5.com. Test and find the best variables for profitability. Make changes to the system to find the best settings for your Forex trading style and risk tolerance.
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