In a recent post, I suggested that Bollinger bands *might* be useful in a trading strategy by themselves but warned that it could be risky. Let’s take a look….
If you had made a trade in the past 30 years based solely on a high Bollinger band reading, more often than not, the stock price would have risen in five days. But if you had invested all of your money in several trades that way in sequence, odds are, you would have lost money! How is that possible?
It’s simple: When you lose money on the stock market, you have to make a larger percent gain in order to make back your money. If you have a 25% loss, you need a 33% gain just to break even. Three 25% gains are more than wiped out by a single 50% loss.
This chart was prepared by calculating the geometric average of all possible 5-day changes from close to close in the Yahoo! Finance stock market historical data available on January 13, 2011 across bins of 0.1 deviations (eliminating any stocks that had ever traded below $1). While it implies that stocks that are far below their lower Bollinger bands may be profitable short-term purchases, some care should be taken in interpreting this chart, as it may understate the risk for purchases. In addition, this chart should not be used as a substitute for simulation, and past performance is not always an indicator of future results.
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