Crypto traders often employ Bollinger Bands as a volatility gauge and a source of potential entry and exit points. In this piece, we will discuss how they are determined and how they might aid in identifying trading opportunities.
The Bollinger Bands
- John Bollinger, an American asset manager and technical analyst is credited with creating the Bollinger bands. In 1980, he went out as a trader and eventually found a home at the Financial News Network, later purchased by NBC. He started Bollinger Capital Management and offered analysis on CNBC.
- The MTA and the FTA (Federation of Technical Analysts) boards benefited from his presence (FTA). Bollinger modeled his bands after Keltner’s and Donchian channels, emphasizing volatility standard deviation to make them flexible. Bollinger Bands was first mentioned on a Fox Business Network show by complete accident.
What are Bollinger Bands?
John Bollinger, an American asset manager, and technical analyst developed the Bollinger Bands in the 1980s. These bands are described as three superimposed lines over asset values.
- The solid line in the center is a Simple Moving Average (SMA) calculated over N time increments.
- The top band is calculated as the mean line’s value plus k times the price’s SD.
- The bottom band is calculated as the mean minus K times the price’s SD.
As a result, we may derive the upper and lower bounds using mathematics as follows:
SM a k x SD.
Most platforms have the Bollinger Band settings pre-set with N = 20 and k = 2. However, you are free to change these numbers and try other trading strategies. For example, the simple moving average may be substituted with an exponential one, and k need not be an integer or more significant than 1. Feel free to use your imagination while making trades.
The following BTCUSD 1-hour chart demonstrates how to use the method above to draw an “envelope” or “channel” around the price:
The preceding graph shows that the upper and lower bands’ bandwidths (the difference between them) expand and contract when volatility changes. When the bands are broad, market volatility is high; when they are tight, volatility is low.
Looking at the behavior of the bands makes it easy to identify times of high and low volatility. When volatility rises and bands narrow, there is a greater likelihood of extreme price swings.
Bollinger bands also identify extremely oversold and overbought regions about the moving average, which is an intriguing character in its own right. A trend reversal is likely to occur when fresh highs and lows are produced outside the bands, followed by highs and lows established within the bands.
Lastly, Bollinger bands may only sometimes indicate a trend reversal. Still, they can identify a trend continuation pattern, such as when the price breaks out above the upper band or below the lower band, respectively. Unfortunately, even though this is a fundamental principle, many new traders overlook it in favor of constantly scanning for tops and bottoms around the bands.
Knowing how to compute and interpret Bollinger bands, we can go on to review several techniques that make use of them.
How To Use Bollinger Bands in Your Trading
As we’ve already shown, Bollinger bands may serve as both reversal and continuation indicators. The following methods make use of this property of the bands:
1) Bollinger Bounce
- This is the simplest method for trading bitcoins using Bollinger bands. Since the lower band indicates the oversold levels and the overbought levels, traders should buy when the market is at or near the lower band and sell when it is at or near the upper band. Simple, eh?
- Hold up a minute! You need to know the market circumstances before trading the Bollinger bounce. How would you characterize the current price action? This tactic will work like a charm in the first scenario, but you can expect to lose a lot of money in the second.
- As luck would have it, Bollinger bands give criteria to identify when the market is in a trendless mode: if the bands are virtually flat, it’s time to trade the Bollinger bounce method.
- As an example, please review the LTCUSD 4-hour chart below. Any time a circle is green, it may be an excellent time to make a purchase, whereas any time it’s red, it’s best to sell.
The bounce approach is practical when the Bollinger band slope is flat, but what happens when the price breaks over the upper band and does not return? When this occurs, it is best to avoid trading the Bollinger bounce. We must place our stop loss levels near our entry point while trading with this technique.
2) Bollinger Squeeze
- Bollinger bands may also be used to identify whether a new trend is emerging. Wait for a candle to close above or below the bands when they begin to widen after a prolonged period of low volatility. If you see this formation, you may profit by trading in the direction of the breakout.
- In the accompanying Ripple 4-hour chart, we can see a textbook case of a Bollinger squeeze. After many days of minimal volatility in the market, a big bullish candle breaks above the upper band (green circle). Following the breakthrough, XRPUSD began a dramatic ascent, eventually gaining over 100% and making numerous new highs above the upper band.
Conclusion
You may learn a lot about market volatility and excellent trading chances by using Bollinger bands. Nevertheless, remember that Bollinger bands are best understood in the context of the prevailing volatility regime. So, it would help if you didn’t rely on them only as an O/S indicator.
It is also wise to use many indicators rather than just one. For example, to better determine entry and exit points, it is recommended to use a combination of Bollinger bands and another indicator, such as the relative strength index (RSI) or the relative strength index (ADX). By doing this, you may improve your chances of making money in the market.
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