The Profitability of a Combined Signal Approach: Bollinger Bands and the ADX

Abstract

This article looks at the profitability of a trading rule based on Bollinger bands applied over 1995 to 2012 in 6 different equity markets using large-cap indices (CAC, DAX, FTSE, HSI, KOSPI, NIKKEI). In addition, we also explore the performance of a trading strategy based on a combined signal approach, with Bollinger band signals filtered using the ADX to avoid trending markets. While the trading strategy based solely on these indicators would underperform a buy and hold strategy in most of the markets studied, we find evidence supporting the use of Bollinger bands for tactical trades over short time horizons as evidenced by return distributions with a strong positive skew. When comparing the performance of Bollinger bands with the strategy augmented by the ADX, we find little performance improvement when applied on a systematic basis as an initial filter. However, the ADX can still act as a useful tool when applied on a discretionary basis to limit losses.