Bollinger Bands Reversal

Understanding Bollinger Bands

Bollinger Bands are a versatile technical indicator that helps you visualize volatility and price trends. They consist of three lines: the middle band, which is usually a 20-period simple moving average (SMA), and two outer bands that are typically set two standard deviations above and below the SMA. These outer bands expand and contract based on market volatility. When price action nears the upper band, it indicates potential overbought conditions, while nearing the lower band suggests potential oversold conditions. You can use Bollinger Bands to track price movements, anticipate volatility shifts, and pinpoint possible trend reversals.

Why Bollinger Bands Are Useful for Reversals

You can leverage Bollinger Bands effectively to spot potential reversal points. When the price pushes outside the upper or lower bands, it’s often a signal that the current trend is overextended, and a reversal could be imminent. For example, if price breaks below the lower band but then quickly reverses upward, you might catch a long opportunity as the price reverts to the mean (the middle SMA). Similarly, a move above the upper band followed by a sharp reversal downward can signal a short opportunity. These bands give you an intuitive way to spot possible reversals and time entries and exits based on price action relative to volatility.

Step-by-Step Guide to Building the Bollinger Bands Reversal Indicator

Step 1: Define the Upper and Lower Bollinger Bands

To start, we define the upper, lower, and mid Bollinger Bands, which serve as the core of this indicator. ThinkOrSwim has a built-in function for Bollinger Bands, so we’ll leverage that here:

def lowerBand = BollingerBands().lowerBand;
def upperBand = BollingerBands().upperBand;
def mid = BollingerBands().MidLine;

The lowerBand and upperBand lines represent two standard deviations from the simple moving average (SMA), which is mid. These three lines will frame our trading signals based on price movements around them.

Step 2: Define Conditions for Signal Generation

This indicator requires certain conditions to be met for generating buy and sell signals. We need conditions for the price to be outside the Bollinger Bands and for additional validation to reduce false signals:

# Requirement 1
def cond1 = low[1] < lowerBand[1]; def cond2 = high[1] > upperBand[1];

# Requirement 2
def cond3 = close > high[1];
def cond4 = close < low[1];

# Filter out false signals:
def cond5 = high < mid; def cond6 = low > mid;

These conditions work together to determine our buy and sell signals. Specifically, cond1 and cond2 check if the price has moved outside the bands, while cond3 and cond4 confirm that a reversal candle has occurred. cond5 and cond6 add a filter for signals by verifying the relationship between the price and the midline.

Step 3: Define Buy Signal

The buy signal triggers when the price meets all conditions for a long trade. We’re also setting the appearance of the signal with a plot style and line weight:

plot bullSignal = cond1 and cond3 and cond5 and low <= 20;
bullSignal.SetPaintingStrategy(PaintingStrategy.BOOLEAN_ARROW_UP);
bullSignal.SetLineWeight(3);

The bullSignal appears when the price is below the lower Bollinger Band, the close is above the previous candle’s high, and the high is under the midline. We apply a visual style using BOOLEAN_ARROW_UP to plot an upward arrow when these conditions are met.

Step 4: Define Sell Signal

Now, let’s define the sell signal, which operates similarly but focuses on the price exceeding the upper Bollinger Band:

plot bearSignal = cond2 and cond4 and cond6 and high >= 30;
bearSignal.SetPaintingStrategy(PaintingStrategy.BOOLEAN_ARROW_DOWN);
bearSignal.SetLineWeight(3);

The bearSignal plots a downward arrow whenever the price meets all conditions for a sell setup. It appears when the high exceeds the upper band, the close is below the previous low, and the low remains above the midline, indicating a potential bearish reversal.

Step 5: Customize Signal Settings

ThinkOrSwim allows for signal customization, so feel free to adjust the low <= 20 and high >= 30 conditions in both bullSignal and bearSignal. These parameters let you refine how extreme the conditions should be before a signal plots.

Step 6: Add to Your ThinkOrSwim Chart

Once you’ve entered the code, save it as a custom indicator by going to Studies > Create, then naming and saving your code. Afterward, you can load it onto any chart in ThinkOrSwim:

1. Go to the Studies icon.
2. Select “Create” to start a new custom indicator.
3. Copy and paste the code from the tutorial into the editor.
4. Save and apply the indicator to see it in action.

With the Bollinger Bands Reversal Indicator now on your chart, you should see the buy and sell signals plotted based on the conditions coded above.

Conclusion

That brings us to the end of this tutorial!

Hopefully, you’ve learned how to not only build this Bollinger Bands Reversal Indicator, but also understood why it provides a solid foundation for reversal-based trading strategies (particularly suitable for mean reversion setups). As with any strategy, consider testing it thoroughly on a demo account or historical data before using it in live trading.

Use this as a starting point for building more complex strategies!

Thanks for following along, and as always, good luck trading!