When Bollinger meets Edgeworth: An application to the contrarian trading strategy

Abstract

The architecture of Bollinger Bands significantly contributes to informed decision-making in financial markets. This paper introduces two new techniques that incorporate Edgeworth correction for confidence intervals in classical Bollinger Bands (BB). In this regard, skewness and kurtosis are included to create Adjusted Bollinger Bands (ABB) with the aim of implementing a contrarian trading strategy. The performance of these techniques was evaluated on the 30 stocks of the Dow Jones Industrial Average Index and compared with performance metrics grouped by returns, risk, and risk-return measures, including the Sharpe ratio, Omega ratio, and Information ratio, and others. Results demonstrate the outperformance of our proposal based on ABB strategies over the classical BB for different periods, such as 6 and 10 days. The effectiveness of the approach presented in this paper exhibits a significant contrast to the traditional Bollinger Band methodology. Furthermore, these results are substantiated using robust statistical tests such as the Jonckheere-Terpstra Test.