Understanding Bollinger Bands & How it Works For Crypto Trading
Bollinger Bands was introduced by John Bollinger as a technical trading tool in the early 1980s. The concept was born due to the need for adaptive trading bands and the realization that volatility was not static, as was widely believed, but dynamic.
Bollinger involves the strategy of using moving averages with two trading bands. This is pretty similar to using the basic moving average. However, unlike using a percentage computation from a typical moving average, Bollinger Bands add and subtract a standard deviation calculation. Read on to discover what this indicator entails and how it works.
What Is a Bollinger Band?
In simple terms, Bollinger bands measure volatility in price action and tell a trader points in time where the price is highly likely to continue or reverse direction. Bollinger Bands are essentially used to define relatively high and low. This is an indication of prices being “high” at one end and “low” at the other end. Interpreting this can help traders identify unusual price movements, as well as compare the price action to indicator action to effect better trading decisions.
Bollinger Bands are also used to identify oversold and overbought situations in the crypto markets. It is frequently used in crypto trading but has been applied in other financial markets, including stocks and forex markets. The rule of thumb is when Bollinger bands close outside of a 2.0 standard deviation, upper or lower band, a reversal is likely to occur because the price will spend 99% of its time inside the bands, so when a close outside a band, we have a high probability of a reversal.
How does Bollinger Band work
Basically, Bollinger Bands consist of:
- Moving Average
- Lower Band
- Upper Band
The moving average, typically 20 periods, forms the center of the Bollinger Band. The upper Bollinger Band is two standard deviations above the moving average line, and the lower Bollinger Band is two standard deviations below the moving average line.
Generally speaking, 95% of values should be between two standard deviations. Therefore, it is a rare occurrence when asset prices increase above or below the Bollinger Bands. However, since the moving average and standard deviations used for the Bollinger Band calculation are based on historical values, combining them with other indicators for more accurate prices between the upper and lower Bollinger Bands is essential.
How to Use Bollinger Bands in Crypto Trading?
Pretty much the same as using Bollinger Bands in traditional markets, cryptocurrency trading is no different, only that volatility is more prevalent, opening up more trading opportunities and signals from this specific indicator.
Here is how you should set the Bollinger Bands depending on the trading style:
- Day Trading — Simple Moving Average with period 10 and bands at 1.5 standard deviations;
- Swing Trading — Set SMA with period 20 and bands at 2 standard deviations.
- Position Trading — Use a 50-day SMA and bands at 2.5 standard deviations.
The Bollinger Band theory will not indicate exactly which point to buy or sell an option or stock. It is meant to be used as a guide (or band) with which to gauge a stock’s volatility.
When a crypto asset’s price is very volatile, the Bollinger Bands will be wide apart. Technical indicator charts display a far gap. Conversely, when there is little price fluctuation, hence low volatility, the Bollinger Bands will be in a tight range. This is depicted as narrow “lanes” along the chart.
Why are Bollinger Bands so useful?
Bollinger bands perform three major functions for traders:
The spacing, or width of the band, is dependent on the volatility of the market. As a result, it gives traders a clear indication of where prices will go and when to enter.
2. Timing Entry Levels in a Trend
We all know long-term currency trends last for months or years — but we need to get in at the best risk/reward level. Bollinger bands will help traders spot trends and determine a good entry. All you do is watch for dips toward the center band — and enter in the direction of the trend — it really is that simple!
3. Spotting Market Reversals
When an asset price touches the top of the band, a sell is generated, and prices should revert back to the mean or the middle moving average band. If the price touches the bottom of the band, traders can buy a currency, assuming that it is oversold, and will rally back toward the top of the band.
Overall, Bolligar banks are a primary charting tool to get the big picture — and the best timing indicator to filter out “false” signals in the crypto market. Bollinger bands are a resourceful tool — but they need to be combined with other indicators. As with any single indicator, they should not be used alone.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.