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Lesson 07 · Mean reversion

Bollinger Bands Strategy: Mean Reversion in a Range

  • 13 short cards
  • About 5 min to read
  • 5 quiz levels · 30 questions
  • Beginner

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Overview

Bollinger Bands draw an envelope around price that widens when the market gets livelier and narrows when it calms down. This Bollinger Bands strategy is a mean reversion trade for sideways markets: buy after price stretches below the lower band, and aim for the middle.

Timeframe
1-hour to daily charts
Markets
Forex, indices, shares moving sideways
Difficulty
Beginner

Builds on: Moving Average Crossover Strategy, RSI Trading Strategy: Buying Oversold Dips

See it on a chart

949698100102104106BuyBuyBuyBuySell
  • Price (candles)
  • Bollinger Bands (20, 2)
  • Long signal
  • Short / exit signal

A sideways market. A close outside a band, followed by a close back inside, marks each signal. Prices are made up for illustration.

How Bollinger Bands work

John Bollinger’s bands have three lines126. The middle band is a 20-period simple moving average. The upper and lower bands sit two standard deviations above and below it.

Standard deviation is a measure of how spread out prices are around their average3. When prices swing a lot, it is large, so the bands move apart. When prices are calm, the bands move closer together.

Worked example: where the bands sit

Middle band (20-period average)
£50.00
Standard deviation
£1.25
2 standard deviations: 2 × £1.25
£2.50
Upper band: £50.00 + £2.50
£52.50
Lower band: £50.00 − £2.50
£47.50

If prices start swinging more, the standard deviation grows and both bands move further out.

The Bollinger Band mean reversion trade

In a sideways market, a close below the lower band often means price has stretched too far, too fast. This strategy waits for the next candle to close back inside the band, then buys and aims for the middle band. The same idea works the other way at the upper band, for short trades.

This is the same mean reversion idea as the RSI lesson, but measured with bands instead.

The trade, step by step

  1. Check it’s sidewaysThe middle band is roughly flat
  2. A stretchA candle closes below the lower band
  3. Back insideThe next candle closes inside the band: buy
  4. TargetThe middle band

Touching a band is not a signal on its own

Bollinger himself says a touch of a band is not a buy or sell signal by itself1. In a strong trend, price can hug one band for many candles. This is called walking the bands1.

So this strategy only suits sideways markets. Check that the middle band is roughly flat. You can also use the ADX from Lesson 4: a reading below 20 suggests there is no strong trend.

When to use the bands, and when not to

Sideways: this strategy fits

  • Middle band roughly flat
  • Price bounces between the bands
  • ADX below about 20

Strong trend: stand aside

  • Middle band slopes steeply
  • Price “walks” along one band
  • A band touch is not a signal

The squeeze: a time not to fade

When the bands get unusually narrow, it is called a squeeze4. A squeeze often comes before a big move. That makes it a poor time to bet on price returning to the middle.

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  • Price (candles)
  • Bollinger Bands (20, 2)

A squeeze: the bands get very narrow while price goes quiet, then price breaks out and the bands widen fast. Betting on a return to the middle during a squeeze is risky. Prices are made up for illustration.

Measuring where price sits: %B

%B shows where price is compared with the bands5: 0 means at the lower band, 0.5 at the middle band and 1 at the upper band. Below 0 means price is outside the lower band.

Reading %B

BelowInside the bandsAbove0 = lower band0.5 = middle1 = upper band
-0.21.2

%B = (price − lower band) ÷ (upper band − lower band). With bands at £47.50 and £52.50, a price of £49 gives (£49 − £47.50) ÷ £5 = 0.3.

Bollinger Bands trading rules

Entry

  • The middle band is roughly flat (sideways market).
  • Price closes below the lower band.
  • The next candle closes back inside the band: buy.

Exit

  • First target: the middle band.
  • Optional second target: the upper band.
  • Get out if price closes below the low of your signal candle.

Risk

  • Stop just below the lowest point of the move.
  • Skip it when the bands are widening fast or the middle band slopes steeply.
  • Avoid trading just before major news.

Worked example: buying near the lower band on EUR/USD

  1. EUR/USD has moved between 1.0800 and 1.0950 for six weeks, with a flat middle band at 1.0875.
  2. Price drops sharply and closes at 1.0790, below the lower band at 1.0805.
  3. The next candle closes back inside, at 1.0815. You buy at 1.0815.
  4. Your stop goes at 1.0775, below the low of 1.0782: 40 pips of risk.
  5. Your target is the middle band at 1.0875, 60 pips away: a reward-to-risk of 1.5-to-1.

Pros and cons of Bollinger Band reversion

Strengths

  • The bands adjust automatically to how lively the market is.
  • Clear targets at the middle and opposite band.
  • Works well in genuine sideways markets.

Weaknesses

  • Loses repeatedly when a trend starts and price walks the band.
  • Needs a separate check that the market really is sideways.
  • The reward is often not much bigger than the risk.

Key terms

Standard deviation
A measure of how spread out prices are around their average.
Middle band
The 20-period simple moving average in the centre of the bands.
Walking the bands
Price hugging one outer band during a strong trend.
Squeeze
Unusually narrow bands, often before a big move.
%B
Where price sits within the bands: 0 at the lower band, 0.5 middle, 1 upper.

Lesson complete

You have reached the end of the lesson. Now test what you learned with the five-level quiz.

Start the quiz

Quiz zone

Test yourself: Bollinger Band Mean Reversion quiz

Five levels, from the basics to expert judgment. Clear each level to unlock the next.

  1. Level 1: Foundations. Recognise the strategy and its vocabulary.
  2. Level 2: Mechanics. Know how the signals and rules work, and why.
  3. Level 3: Application. Apply the rules to realistic chart situations.
  4. Level 4: Numbers & risk. Size, measure and manage the trade with real calculations.
  5. Level 5: Mastery. Judge edge cases, failure modes and market conditions.

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See all 30 questions in this quiz

The questions only. Answers and explanations appear when you take the quiz above.

Level 1: Know the bands

  1. What is the middle Bollinger Band usually?

    • The RSI
    • A 20-period simple moving average
    • The highest price of the day
    • A 200-day moving average

  2. The outer bands sit a number of ___ away from the middle band.

    • candles
    • percentages
    • standard deviations
    • pounds

  3. True or false: Bollinger Bands move apart when the market gets livelier.

    True or false?

  4. In this strategy, what is the usual first profit target?

    • Twice the entry price
    • The upper band
    • The middle band
    • There’s no target

Level 2: Understand how the bands behave

  1. Why wait for a candle to close back inside the band before buying?

    • It’s required by brokers
    • The bands are wrong until then
    • It shows the stretch has stopped, so you’re less likely to buy a falling price
    • It gets you a lower price

  2. True or false: price touching the upper band is a reliable sell signal on its own.

    True or false?

  3. What does “walking the bands” mean?

    • The bands disappear
    • Price moves from one band to the other
    • The bands move sideways
    • Price hugs one outer band during a strong trend

  4. A %B reading of 0 means price is…

    • at the middle band
    • at zero pounds
    • at the upper band
    • at the lower band

  5. Which kind of market does this strategy suit?

    • A market that has just broken out
    • Any market
    • A sideways market with a roughly flat middle band
    • A strong uptrend

Level 3: Use the rules

  1. The middle band is flat and price has bounced between the bands for weeks. It closes below the lower band, then back inside. What fits the rules?

    • Sell short
    • Buy only if RSI is above 70
    • A valid buy, with a stop below the low
    • No trade: wait for the upper band

  2. The middle band is rising steeply and price has closed above the upper band five days running. Should you sell short?

    • Yes, with double size
    • No: this is walking the band in a strong uptrend
    • Yes: price is stretched
    • Only on a Friday

  3. The bands are at their narrowest in six months. What’s sensible for a mean reversion trader?

    • Stand aside: a squeeze often comes before a big move
    • Sell at the upper band
    • Trade bigger than usual
    • Buy at the lower band

  4. You bought near the lower band, and price has reached the middle band. What do the rules suggest?

    • Move your stop lower
    • Take at least some profit at the middle band
    • Buy more
    • Hold until the upper band no matter what

  5. Where does the stop go on this trade?

    • There’s no stop
    • Just below the lowest point of the move
    • Above the upper band
    • At the middle band

  6. A big interest-rate decision is due in an hour. Price has just closed back inside the lower band. What do the rules say?

    • Buy straight away
    • Buy double
    • Avoid trading just before major news
    • Use no stop because of the news

Level 4: Work out the bands

  1. The middle band is £50.00 and the standard deviation is £1.25. The bands are 2 standard deviations out. Where is the upper band, in pounds?

    Type a number.

  2. Same values: middle £50.00, standard deviation £1.25, 2 standard deviations. Where is the lower band, in pounds?

    Type a number.

  3. Price is £49.00. The lower band is £47.50 and the upper band is £52.50. What is %B? (%B = (price − lower) ÷ (upper − lower).)

    Type a number (%B).

  4. Price is £46.50. The bands are £47.50 and £52.50. What is %B? Type a minus sign if it’s below zero.

    Type a number (%B).

  5. You buy EUR/USD at 1.0815 with a stop at 1.0775. How many pips are you risking?

    Type a number (pips).

  6. You buy EUR/USD at 1.0815 and your target is the middle band at 1.0875. How many pips is that?

    Type a number (pips).

  7. Your target is 60 pips away and your stop is 40 pips away. What is the reward-to-risk? Type the first number of “? to 1”.

    Type a number (to 1).

Level 5: Judge market conditions and costs

  1. The bands are the narrowest in six months. Then price closes far above the upper band on heavy volume. What’s the most likely reading?

    • A normal day
    • The bands are broken
    • A possible breakout from a squeeze. Betting against it is risky
    • A perfect short: price is stretched

  2. Someone says “95% of prices always stay inside the bands”. Why is that misleading?

    • That figure only fits perfectly bell-shaped data. Real markets have more extreme moves
    • It’s exactly right
    • Bands don’t contain prices at all
    • The real figure is 50%

  3. Which extra check best suits Bollinger Band mean reversion?

    • A low ADX reading, such as below 20, to confirm there’s no strong trend
    • A rising 200-day average
    • A high RSI
    • A golden cross

  4. Your trades win 58% of the time. Wins average 1.2R and losses 1R. Costs are 0.1R a trade. What is the expectancy after costs?

    • About +0.70R a trade
    • Exactly zero
    • About −0.20R a trade
    • About +0.18R a trade

  5. The bands are widening fast and the middle band has started to slope down steeply. What do the rules say?

    • Buy at the lower band
    • Skip it
    • Ignore the slope
    • Trade double

  6. How is this strategy like the RSI strategy in Lesson 6?

    • They have nothing in common
    • Both use mean reversion: stretched prices often snap part of the way back
    • Both follow trends
    • Both buy breakouts

  7. You bought after a close back inside the lower band. Next day price closes below the low of your signal candle. What do you do?

    • Remove the stop
    • Get out
    • Buy more
    • Wait for the middle band

  8. In the EUR/USD example, the reward-to-risk is only 1.5-to-1. What does that mean for the win rate you need?

    • You can win less often than with a 3-to-1 strategy
    • You must win every trade
    • Win rate doesn’t matter
    • You need to win more often than with a 3-to-1 strategy to make money

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