Constructing mechanical rules from Bollinger Bands and stochastics

Write a testable procedure

A mechanical trading system is framed as one or more indicators applied through explicit rules so the procedure can be tested instead of being used informally.

The intended role of the system is to support trading decisions, constrain emotion, and separate technical ideas the designer trusts from ideas that remain untested.

Normalize the close on the bands

Bollinger Bands are volatility envelopes set a stated number of standard deviations above and below a moving average of price. They are used here as the reference extremes for the close.

A close beyond either Bollinger Band was treated as a momentum condition showing a large move already under way, not as a mark of when that move would end.

Percent-b maps the close onto the current Bollinger Bands so a close at the lower band equals 0, a close at the upper band equals 100, and a close outside the bands is below 0 or above 100. It is described as a one-day stochastic that substitutes the bands for the period high and low.

Hold until the close fails

After a close moved outside a Bollinger Band, the first hold rule kept the position until the close reversed versus the prior close. That close-reversal hold stays in the trade until the latest close fails relative to the prior close.

A candlestick reversal was noted as an alternative that does not always appear.

Attach the protective exit after both band rules exist

The preferred exit remained an opposing band-based reverse. The stochastic rule was reserved as the backup if the anticipated continuation failed.

A 14-period stochastic supplied a protective long exit when percent-D was below its slow counterpart and percent-D was below 80. That protective exit was used when price never reached the opposite band-based entry.

Move thresholds only after both exits are written

To raise the number of signals without abandoning the breakout-and-hold idea, the bands were narrowed from 2.0 to 1.9 standard deviations and the percent-b trigger levels were moved from 100 and 0 to 95 and 5.

Editorial note: that adjustment is not part of the first writing pass. Students should finish both exits before they are allowed to move a band width or a percent-b threshold.

Test the procedure without fitting a preferred series

The stated test protocol used next-day open execution, both long and short trades, a 5 percent equity stop, a 25-dollar commission on each entry and exit, and 5.5 percent interest on idle equity.

A single large-cap series was chosen alphabetically to reduce fitting the rules to a preferred security. Construction guidance was to keep rules aligned with a trusted concept rather than fine-tune them into curve-fitting.