What Are Bollinger Bands and How to Use Them?

Technical analysis is the backbone of trading, providing traders with a methodology to predict future price movements based on historical data. Bollinger Bands is one of the most popular and effective tools among the many technical indicators available.

In this article, we will explore the nature and application of Bollinger Bands, providing traders with actionable strategies to enhance their trading decisions.

What are Bollinger Bands?

John Bollinger, a long-time market technician, introduced Bollinger Bands in the 1980s. These bands aim to summarize the price movements of an asset, offering insights into its volatility and momentum.

Three Lines of Bollinger Bands

1. Middle Band: This is a simple moving average (typically 20 periods).
2. Upper Band: Calculated as the middle band plus two times the standard deviation of the price.
3. Lower Band: Calculated as the middle band minus two times the standard deviation of the price.
   

Start maximizing your crypto trading potential with Bollinger Bands today

Bollinger Bands Strategies for Crypto Trading

Here are some common trading strategies using Bollinger Bands:

1. Bollinger Bounce
   This refers to the price "bouncing" off the upper or lower Bollinger Band. It's based on the idea that the price tends to return to the mean.
   When prices touch the lower band, it might be an oversold condition (buying opportunity); when they touch the upper band, it might be an overbought condition (selling opportunity).
   
   
   

2. Bollinger Squeeze
   This occurs when the bands come together, narrowing the gap between them. A squeeze signals a period of low volatility. It is considered a potential indicator of increased volatility and possible trading opportunities.
   A breakout from the squeeze (i.e., a sharp price move to the up or downside) can be a sign of the start of a trend.
   
   
   
   
   

3. Walking the Bands
   At times, prices might start "walking the band." This can happen during a strong uptrend or downtrend.
   In an uptrend, prices can walk up the upper band; in a downtrend, prices can walk down the lower band.
   This indicates a strong trend; opposing trades are not advisable during such periods.
   
   
   
   
   

4. Bandwidth
   In the Bollinger Bands trading strategy context, "bandwidth" refers to the width or difference between the upper and lower Bollinger Bands. It quantifies the distance between the two bands and provides insight into the market's volatility.
   

Bandwidth Calculation Formula

Bandwidth=((upper band-lower band )/(middle band ))*100

Example

Imagine a crypto named "Zcoin". The 20-day moving average (middle band) is $100. The upper band is $110, and the lower band is $90.

Bandwidth Calculation

Bandwidth=((110-90 )/(100 ))*100= 20%

So, the bandwidth for Zcoin is 20%.

Interpretation

Volatility: The 20% bandwidth means there's some price movement or volatility.

The bandwidth percentage in Bollinger Bands represents the distance between the upper and lower bands relative to the middle band (moving average). Interpreting this percentage gives insights into the market's volatility:

1. Low Bandwidth Percentage (e.g., 5% or less)
   
   Interpretation: This typically signifies low volatility. Prices are relatively stable, and the stock or asset trades in a tight range.
   Implication for Traders: Often called a "squeeze," low bandwidth can be a sign that a significant price movement (breakout or breakdown) is imminent. Traders watch closely for other confirming signals.
   
   
   
   
   

2. Medium Bandwidth Percentage (e.g., between 5% to 20%)
   
   Interpretation: This suggests moderate volatility. The asset is seeing some price fluctuations, but nothing extraordinarily dramatic.
   Implication for Traders: The market might be trending, and depending on the direction of the trend, traders might look for entry or exit points.
   
   
   
   
   

3. High Bandwidth Percentage (e.g., above 20%)
   
   Interpretation: High volatility is indicated. There are substantial price swings, and the market is very active.
   Implication for Traders: Such conditions can be both opportunities and risks. While potential profits can be higher, so can losses. Risk management becomes crucial.
   
   
   4. Double Bottoms and Double Tops
   
   Double bottoms and tops can sometimes be spotted using Bollinger Bands. A double bottom might occur after the price has touched the lower band twice, whereas a double top might occur after touching the upper band twice.
   These patterns can signal reversals if validated with other indicators or significant volume.
   
   
   
   
   

5. Bollinger Band Breakouts

Traders buy when the price breaks above the upper Bollinger Band or sell when the price falls below the lower Bollinger Band.

As with all trading strategies, none of these are foolproof. It's essential to use them with other analysis methods, set appropriate stop-loss levels, and always trade based on a well-thought-out plan rather than emotion.

Ready to trade smarter? Explore the Bollinger Band Breakout strategy with us

What is Bollinger Band Breakout Strategy

The Bollinger Band Breakout strategy is based on the concept that when the price of an asset moves outside of the Bollinger Bands, it indicates a continuation of the current trend, either upward (if breaking the upper band) or downward (if breaking the lower band).

How to Trade Using the Bollinger Band Breakout Strategy:

1. Buy Signal: When the price closes above the upper Bollinger Band.
2. Sell Signal: When the price closes below the lower Bollinger Band.
   
   

Example

Imagine the daily chart of BTC/USDT on a cryptocurrency exchange.

BTC/USDT has been trading within its Bollinger Bands for several weeks. The middle line (20-day SMA) is $40,000, the upper band is $44,000, and the lower band is $36,000.

One morning, after some significant news regarding Bitcoin adoption, you notice that BTC/USDT has surged in price and closed at $45,000, above the upper Bollinger Band.

Based on the Bollinger Band Breakout strategy, this could be a buy signal because the price has closed above the upper band, suggesting the possibility of continuing the upward trend.

Conversely, if BTC/USDT had dropped in response to negative news and closed at $35,000 (below the lower band), it would be considered a sell signal.

Bollinger Bands Best Setting

The most commonly used setting for Bollinger Bands is a 20-day simple moving average (SMA) for the middle band with a 2-standard deviation for the upper and lower bands. This means:

Middle Band: 20-day simple moving average (SMA)

Upper Band: 20-day SMA + (20-day standard deviation of price x 2)

Lower Band: 20-day SMA - (20-day standard deviation of price x 2)

However, there is no universally "best" setting for Bollinger Bands. The optimal settings can depend on:

1. Market Volatility: In more volatile markets, traders might opt for a larger number of standard deviations to reduce the number of false signals.
   

2. Trading Style: Day traders might use shorter periods, like a 10-day SMA, while swing or position traders might opt for longer periods, such as 50 or 100-day SMAs.
   

3. Asset Being Traded: Cryptocurrencies, stocks, and forex might behave differently and require setting tuning.
   

4. The Purpose: The default settings are often adequate if you use the bands primarily to identify overbought and oversold conditions. However, adjust the settings for more sensitivity if you're looking for breakouts.
   

Here are some variations you might come across:

I.Shorter Timeframes (e.g., Day Trading): Some traders prefer using a 10-day SMA with 1.5 standard deviations.

II.Longer Timeframes: A 50-day or even 200-day SMA with 2.5 or 3 standard deviations might be used for more extended position trades or investments.

It's essential to remember that no single setting works best for all trading scenarios. A good approach is to test different settings in a demo environment or through backtesting to find what works best for your trading style and the specific market conditions you trade-in.

Ready to enhance your trading knowledge? Explore the differences between Bollinger Bands and Keltner Channels

Comparison of Bollinger Bands and Keltner Channels

Bollinger Bands and Keltner Channels are technical analysis tools that measure volatility and potential overbought or oversold conditions. While they share similarities, they're calculated differently and have distinct characteristics.

1. Calculation: Bollinger Bands adjust based on the standard deviation of closing prices, making them reactive to specific price movements. Keltner Channels use the Average True Range (ATR), making them responsive to overall volatility.
   

2. Sensitivity: Bollinger Bands are more sensitive to sharp price changes because of the emphasis on standard deviation. Keltner Channels tend to reflect broader volatility trends due to their reliance on the ATR.
   

3. Appearance: Keltner Channels generally appear smoother than Bollinger Bands, as the ATR often filters out minor price fluctuations.
   

Both tools measure market volatility and potential overbought or oversold conditions. The choice between them typically depends on a trader's preference and strategy.

Importance of Using Bollinger Band in Crypto Trading

Using Bollinger Bands in crypto trading can be beneficial for several reasons. Below, we've listed four important reasons for using Bollinger Bands in crypto trading:

1. Volatility Assessment: Cryptocurrencies are known for their high volatility. Bollinger Bands can help traders identify periods of increasing or decreasing volatility, which can precede significant price movements.
   Narrowing the bands (a "squeeze") can indicate a potential big move coming. At the same time, an expansion may suggest a strong trend is underway.
   

2. Overbought/Oversold Indicators: When a cryptocurrency's price touches or moves outside the Bollinger Bands, it might be indicative of overbought (when touching/moving above the upper band) or oversold (when touching/moving below the lower band) conditions. Depending on the broader context, this can signal potential price reversals or trend continuations.
   

3. Trend Identification: Bollinger Bands can also help identify a trend's strength and direction. For instance, if the price is consistently hugging the upper band, it might be in a strong uptrend, and vice versa for the lower band.
   

4. Price Targets and Stops: Traders can set price targets or stop-loss points based on the bands. For instance, a trader might set a price target near the upper band after entering a long position when the price touches the lower band.

Conclusion

In conclusion, Bollinger Bands serve as a vital tool for crypto traders, offering insights into market volatility and potential entry and exit points. As the cryptocurrency market is known for its rapid price fluctuations, having such a reliable indicator can be invaluable.

By understanding and effectively utilizing Bollinger Bands, traders can make more informed decisions, maximizing their chances of success in the dynamic world of crypto trading.

FAQs

1. What does a squeeze in Bollinger Bands indicate?

A squeeze in Bollinger Bands refers to the bands coming closer together, indicating decreased volatility and a potential upcoming breakout.

2. How are Bollinger Bands useful in crypto trading?

Bollinger Bands help identify volatility, overbought and oversold conditions, and potential price reversals or continuations.

3. What are Bollinger Bands?

Bollinger Bands is a technical analysis tool consisting of three lines: a middle line being the simple moving average (SMA) and two outer lines representing standard deviations above and below the SMA.

4. Most common Bollinger Bands Strategies for Crypto Trading?

Here are the two most common Bollinger Bands Strategies for Crypto Trading:

I.Bollinger Bands Squeeze:

This strategy identifies periods when the Bollinger Bands come closer together, indicating low volatility. A "squeeze" often precedes a significant price breakout. Traders watch for a subsequent band expansion to initiate trades in the breakout's direction.

II.Bollinger Bounce:

The basic premise of this strategy is that the price tends to revert to the middle band (the simple moving average) after moving towards the outer bands. Traders buy when the price touches the lower band and look to sell when the price touches the upper band, especially in range-bound markets.

5. How do I identify false signals with Bollinger Bands?

Combining Bollinger Bands with other technical indicators and understanding the broader market condition can help filter out false signals.