How to Play the Bounce!

By: Hugo McDougall in Forex Consultant on Aug. 18, 2010


CLASSICAL BOUNCE TRADE SET UP

by Abe Cofnas

 

This morning I saw a classical set up for a bounce trade and I can’t resist providing it to you.

Using a 15 minute chart on the USDJPY we see two Bollinger Bands.  The standard band has a 20 and 2 set up. The additional band, I am calling the Outer Bollinger band has a 13 and 2.618 set up.   The set-ups represent two technical metrics. First, the simple moving average.  So the standard band as a simple moving average of 20 periods and the Outer band have a simple moving average of 13 periods.  The second part of the set-up represents Standard Deviation. Simply put 2 standard deviations means that the price is about 97% of the time between the two bands.  The Outer band has a 2.618 Standard Deviation which means that the price is about 99% of the time between the two bands, if you use the 13 moving average.  

But let’s get to the meaning of this without too much fuss over the statistics.  Tactically, when we see a price point move near or outside both bands, we can conclude its doing something quite extreme. The implication is that the price can’t stay there too long.  Either it’s going to keep going up, or reverse.  Keep in mind that in currencies, the price probing an extreme is not in itself a reversal signal. It got extreme for a reason!  The reason or sentiment has to change for a reversal to occur.   But there is a clue, to the set-up as to whether we have a bounce or reversal scenario.  The clue is the shape of the Bollinger Bands.  If the bands are flat or sideways, it is a good geometry for bounces.  Think of a ball bouncing off a floor. A flat floor generates a straight up bounce!  (Click chart to enlarge)

 

 

Let’s go back to the chart.  You can spot bounce points in either direction after the price went outside the first band, rose to probe the second and penetrated the second outer band, but then reversed back in!  Traders using one band don’t get the added perspective of two bands! 

 

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

 

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