Mean Reversion using Bollinger Bands Trading Strategy

Do you want to know more about Bollinger Bands, mean reversion indicators and mean reversion trading? Read this article to find out how to trade a mean reversion using the Bollinger Bands Trading Strategy.

Mean Reversion Trading Strategy

In this video, I look at an indicator called the Bollinger Bands. This is an indicator that uses a moving averages as the “mean” of the market. In other words, it’s where the market “should” be in general. That is the centerline of the 3 lines that plot on the chart. The other 2 are based upon 2 standard deviations from the normal pricing. In statistics, 95% of all distribution in a sample set typically falls within 2 standard deviations, and the Bollinger Bands try to form trading signals based upon this mindset.

Looking at the chart, you can see that every time the market gets a bit oversold, and typically will try to reach towards the middle line as we go along. The first couple of trades that I point out in this chart are small ones, because they are oversold and we simply go to the moving average. However, you would’ve known this at a time as the Bollinger Bands were fairly narrow. This means that there isn’t a whole lot of volatility in the marketplace, so we are fairly quiet.

If you follow the trend overall, typically you do better. There is a trade on this chart that fired off a buy signal, that didn’t reach the mean until lower prices, which of course would have been a loss. However, it should be noted that we were in a downtrend at that point.

Without a doubt, the most common way to trade this market is to simply trying to aim for the norm of the indicator, which of course is the moving average, but some people do try to buy oversold conditions and aim for overbought conditions. Of course, they work in the opposite direction as well but that tends to be the more aggressive and dangerous way to trade this particular indicator. You can make an argument that we do go back and forth eventually, but the “safest” way is to simply look for normalcy.

There is an argument to be made that Bollinger Bands need a relatively steady and call market, which makes sense considering we are looking for the norm and not the extreme. It should be noted that this is one of the most well-known trading environment, as it allows you to take a little it’s and pieces of the market as we either continued to climb or fall, going with the trend and has been used for decades in the stock markets.