2 Great Bollinger Band Trading Strategies

I recently updated Incredible Charts’ Bollinger Bands page to highlight two great trading strategies:

First, if you are not familiar with Bollinger Bands here is a quick summary of basic Bollinger Band trading signals.

Bollinger Band Squeezes

The traditional way of trading the Bollinger Band squeeze is on breakout above (or below) the bands after a squeeze. Now Microsoft had been trending upward since 2012 and another advance was likely. It is important to guard against fake signals in the opposite direction, like the one highlighted in mid-September 2016.

Microsoft Bollinger Band Squeeze with Twiggs Money Flow

  • Green arrow = Long entry
  • Red arrow = Exit
  • The red candle on Friday, September 9th closed below the lower band after a narrow Bollinger squeeze, signaling a downward break, before a large engulfing candle on Monday warned of reversal to an up-trend. The primary trend would alert traders to treat shorter-term bear signals with caution but it is also advisable to use Twiggs Money Flow to confirm buying or selling pressure. Here 21-day Twiggs Money Flow is oscillating above zero, indicating buying pressure despite the downward breakout. So the trade would be ignored.
  • Subsequent rising troughs on Twiggs Money Flow would give me sufficient confidence to enter the trade [green arrow] before the next breakout, with a stop below the recent low at $56. More cautious traders would wait for breakout above the upper Bollinger Band but this often gives a wider risk margin because the stop should still be set below $56. The subsequent pull-back to test support in November 2016 underlines the need not to set stops at the breakout level.
  • Exit [red arrow] on bearish divergence on Twiggs Money Flow, when the second dip crosses below zero, or if price closes below the lower Bollinger Band.

Bollinger Band Trends

The second strategy is a trend-following strategy I picked up from Nick Radge’s book Unholy Grails, where he uses 100-day Bollinger Bands to capture trend momentum. The rules are simple:

  • Enter when price closes above the upper Bollinger Band
  • Exit when price closes below the lower Bollinger Band

Nick proposes setting the upper band at 3 standard deviations and the lower band at 1 standard deviation but I am wary of this (too much like curve-fitting) and would stick to bands at 2 standard deviations.

Here I have plotted Microsoft with 100-day Bollinger Bands at 2 standard deviations and 13-week Twiggs Money Flow to highlight long-term buying and selling pressure.

Microsoft Bollinger Band Trends

For a detailed discussion of trading signals for this chart, go to Bollinger Band Trends.

S&P 500 Prime Momentum 12 month performance

S&P 500 Prime Momentum

The S&P 500 Prime Momentum strategy has now been running for twelve months, since November 2013, and returned 17.46%* for the period compared to 17.27% for the S&P 500 Total Return Index. This is below the average return for the 1996 to 2013 research period and is attributable to the sell-off of momentum stocks in recent months. Macroeconomic and volatility filters continue to indicate low to moderate risk typical of a bull market and we expect stocks to recover in the months ahead.

* Results are unaudited and subject to revision.

When to sell and when to buy?

Investors are faced with the same emotional tug-of-war at every correction: Do I sell and abandon my positions or do I sit tight and ride out the storm? Here are a couple of useful perspectives:

What is your investment time frame?

Do you plan to invest for the long-term (5 to 10 years) or is your investment horizon a matter of months or weeks? If your investment horizon is long-term, you are investing for the primary trend. Your intention is unlikely to be to time secondary market movements.

Is timing secondary corrections profitable?

Our research shows that the average re-entry point, after brokerage and slippage is higher than the exit point and erodes performance.

Has the earning capacity of stocks you hold been affected by the correction?

A correction is a wave of negative sentiment, normally caused by an external shock — like the prospect of higher interest rates, oil prices, some new conflict or a threat to international trade. Where the market decides that earnings are unaffected and there is no permanent loss of value, it tends to recover fairly quickly. If, however, the market decides that there is a long-lasting effect on earnings then stocks are likely to be re-rated — resulting in a long-lasting drop in value. The probability of the former is far higher than the latter: the ratio of primary to secondary adjustments is low.

When is the best time to hold Momentum stocks?

We have not done a wide-ranging study of this, but the best two months performance for our ASX200 Prime Momentum strategy in the last two years were July 2013 (11.00%) and February 2014 (9.04%) — both in the middle of corrections.

ASX 200 Corrections

Attempt to time the correction and you may miss the best-performing months.

To sell or not to sell?

Recent acquisition Northern Star Resources [NST] in the ASX 200 portfolio is a great example of the conundrum faced by long-term investors when a new stock leaps out of the starting blocks. Profit-taking is evident from the tall shadows/wicks early in the week and in the decline of 21-day Twiggs Money Flow. Medium-term selling pressure suggests the stock is likely to retrace and give back some of the gains of the last two weeks. The temptation must be great to sell the stock and lock in profits of close to 30 percent.


It is important, however, to stick to the plan. We are investing for a longer time frame in anticipation of much larger gains. There is no guarantee that any individual stock, including NST, will deliver. But I can guarantee you that they will not deliver long-term gains if you sell within the first few weeks.

Investors in S&P 500 stock Micron Technology [MU] faced a similar conundrum in July 2013. The stock had put in a good run from $9.00 before encountering profit-taking as it approached $15.00. 21-Day Twiggs Money Flow retreated below zero and the stock fell back to $12.50. Many investors would have taken this as a sign to get out.

MU July 2013

With hindsight, the decision to stay the course looks easy: support held at $12.50 and MU is now trading at $33.00. But I am sure that there were many investors who forgot their original plan and took profits at $12.50.

MU 2013/2014

….They just aren’t bragging about it.

Understanding Momentum

Understanding Momentum

Since its initial discovery by DeBondt & Thaler in 1985, the momentum effect has been documented and researched in many markets worldwide. Stocks which have outperformed in the recent past tend to continue to perform strongly over the months ahead.

Research conducted by Dr Bruce Vanstone and me indicates that Momentum significantly outperforms the major benchmark indices in both US and Australian markets. Investors, however, tend to focus on the annual rate of return without considering the accompanying volatility. Consider our simulation of Twiggs Momentum on the S&P 500 for the period January 1996 to June 2013 as an example.

S&P 500 TMO Equity Curve: click to enlarge

Dark green areas represent cash holdings, when market risk is identified as elevated. The blue line represents the benchmark S&P 500 index. Click on the image if you need a larger view.

Investment Strategy: Twiggs Momentum Buy & Hold
Starting Capital (USD): $100,000 $100,000
Ending Capital (USD): $4,871,686.27 $258,649.35
Annualized Gain: 24.89% 5.58%
Total Commission Paid (at 5 BPS): $66,194.35 $49.96
Number of Investments: 331 1
Win Rate: 54.38% 100.00%
Average Profit: 44.16% 158.79%
Average Loss: 10.15% 0.00%
Maximum Drawdown: 38.64% 56.77%
Maximum Drawdown Date: 9/11/2006 3/9/2009
Sharpe Ratio: 0.98 0.42

Investors tend to focus on the annualized gain of 24.89% p.a. without really applying their minds to the other statistics in the table. Maximum Drawdown of 38.64%, while lower than the index, means the portfolio is still subject to gut-wrenching volatility. Soaring gains are often followed by sharp falls and it takes strong resolve to stick with the strategy after one of these setbacks. Many investors would have abandoned ship after the first major drawdown in early 2000.

Another factor is the Win Rate of just above 54% which means that over 45% of all stocks purchased are sold at a loss. These are typical statistics for a momentum strategy, but investors can expect a high percentage of stocks to be cut from the portfolio for failing to adhere to the expected growth path. The strength of the strategy, however, is the expected gains on stocks that do adhere to the momentum growth path, with average profits exceeding average losses by a ratio of almost 4 to 1. That is where the excess returns are generated and is the reason why the strategy outperforms the benchmark index.

There are also extended periods where the portfolio remains in cash — long enough for doubts to grow as to whether momentum still works in the markets. My own view is that momentum strategies have been shown to outperform the Dow over the last 100 years and are likely to remain viable for as long as we have stock market cycles.

Coping with the emotional roller-coaster ride of investing in stocks is never easy, but here are some hints.

  • Focus on your investment time horizon of at least 5 years.
  • Check stock prices no more than once a week. Tracking prices daily or more frequently tends to cloud your judgement.
  • Welcome gains ahead of long-term averages, but expect them to fade over time.
  • If something unusual occurs, step back from the market, examine the long-term history, and ask: “Is this really unexpected or were my expectations unrealistic.”

That’s all for today. Take care.

How does R&I compare to other investment channels?

DIY investors have several alternative channels for investing in equities. The most hands-off is to invest in managed funds, or a managed discretionary account (MDA), where all investment decisions and actions are made for you. On the other extreme is to purchase investment software that offers a proven investment strategy, where you are responsible for your own investment decisions and execution. In the middle-ground is Research & Investment, where no decision-making is required — other than to invest in a subscription — but you are required to execute your own trades in the market.

Here we compare the relative costs and effort required for each investment channel using a standard investment of $100,000:

Investment Alternative: R&I MDA Software
Upfront cost: $0 $0 $2,000 to $3,000
Ongoing monthly cost: $95 $100 to $200 $50 to $100
Performance fees (above index benchmark): None Up to 22% None
Time & Effort required: 2 to 3 hours/month 0 to 1 hours/month 2 to 3 hours/day
Complexity: Low Very Low High
Mobility & Freedom of movement: High Very High Low
Detachment & Freedom from emotional pressure and external influences: Medium High Low
Investment Timeframe 5 to 10 years
Recommended Leverage: None
Typical Number of Stocks: 10 to 20 Varies Varies
Tax Implications: Suitable for lower tax vehicles such as super funds.
Subscriber Limit: 500 to 1000 Varies Unlimited
Performance: Medium to High Low to High Low to High

Upfront costs are for purchase of investment software.

Monthly costs include R&I subscriptions, management and platform fees for MDAs (from 1.2% to 2.4% of net assets), and data costs for investment software.

Performance fees are calculated on outperformance above a suitable benchmark like the ASX 200 Accumulation Index.

Time required for R&I is to review the update and implement the portfolio changes, normally once a month. A managed account merely requires you to review performance. Investment software normally requires daily scans of the market, review of charts and placing trades with your broker.

Complexity with R&I is limited to reading the updates and placing trades with your broker. A managed account merely requires you to review performance. But investment software requires complex installation and mastery of the operating rules.

Mobility is a problem if you are on holiday or work away from home and need to access your system. R&I requires you to login once a month to receive updates and then place any trades with an online broker. A managed account requires no monthly intervention. Investment software normally requires daily access to the database on your computer to perform scans and daily access to an online broker.

Detachment is achieved if you have a managed account: someone else makes the decisions for you. R&I is a rules-based strategy and requires you to ignore external influences and adhere to the system, implementing all trades. Because of the level of involvement required with investment software, detachment is difficult and investors often stray from the prescribed rules.

Investment time frame is the same for all three vehicles.

Recommended leverage is zero because of volatility of returns.

Typical number of stocks is 10 to 20. R&I is a high conviction strategy, selecting a smaller number of stocks in order to achieve outperformance. Some funds and software follow a similar path, while some erode performance through over-diversification (di-worsification as Warren Buffett calls it).

Tax implications are the same: active strategies do not maximise capital gains tax concessions and require a low tax vehicle such as a SMSF.

Subscriber limits are enforced by R&I to protect performance: too many investors using the same system would affect entry/exit prices and erode returns. Some managed funds are closed or capped, but most are not.

Performance of all three investment alternatives is variable, but by pursuing a high conviction strategy and following a strict, rules-based approach, R&I investors are more likely to outperform the relevant index benchmarks.

We hope you find this comparison useful. To find out more:

  • Visit our home page or FAQ;
  • Open a support ticket; or
  • Call 1300-850-951 (Australia) or +1-866-662-7542 (USA & Canada) on weekdays.

Quant Funds Are Hot Again | Morningstar

By Greg Carlson

Funds that use quantitative stock-picking models are on a roll. A list of 52 U.S.-sold quant funds compiled by Morningstar beat more than 80% of their respective peers over the trailing three years through June 13, and the group outperformed its respective peers in 2011, 2012, 2013, and thus far in 2014.

Read more at Quant Funds Are Hot Again.

Research & Investment: Performance at 30 April 2014

Our ASX200 Prime Momentum strategy returned +30.04%* for the 12 months ended 30th April 2014, outperforming the benchmark ASX200 Accumulation Index by +19.58%.

ASX200 Prime Momentum

The S&P 500 Prime Momentum strategy has been running six months, since November 2013, and returned 7.79%* for the period, compared to 8.36% for the S&P 500 Total Return Index.

A sell-off of momentum stocks affected performance in April, but macroeconomic and volatility filters indicate low risk typical of a bull market and we see current weakness as a buying opportunity.

* Results are before fees, unaudited and subject to revision.

Research & Investment performance update

Our ASX200 Prime Momentum strategy returned +42.10%* for the 12 months ended 31st March 2014, compared to +13.46% for the benchmark ASX200 Accumulation Index.

* Results are unaudited and subject to revision.

ASX200 Prime Momentum

The S&P 500 Prime Momentum strategy has only been running five months, since November 2013, but returned 8.73%* for the period, compared to 6.28% for the S&P 500 Total Return Index.

Research & Investment: Performance update

Research & Investment’s ASX200 Prime Momentum strategy returned +39.20%* for the 12 months ended 28th February 2014, outperforming the benchmark ASX200 Accumulation Index by +28.56%.

ASX200 Prime Momentum

The S&P 500 strategy has only been running since November 2013, but returned +9.35%* for the four months, outperforming the S&P 500 Total Return Index by +2.68%.

* Results are measured from an identical portfolio managed by Porter Capital, are unaudited, and subject to revision.