Crypto Trading Tips: Bollinger Bands Explained
Crypto trading uses several indicators, one of them is bollinger bands, and this article explains how they are used.
Bollinger bands are one of the most actively used financial trading tools and volatility indicators in technical analysis today. Bollinger bands were developed by the American financial analyst, author, and technical analysis contributor John Bollinger in the 1980s and were trademarked as of 2011. Not only has this volatility indicator been used heavily by stock market traders, but it now has a valid use case in analyzing cryptocurrencies.
Bollinger bands are price channels or ‘bands’ that are plotted below and above the price of a cryptocurrency, thus indicating the trading range. The inner line represents a moving average for a specific period and is denoted as a midline. It is essentially the average price of a cryptocurrency over a specific number of days. Bollinger bands typically use a 20-day moving average, which is the average price of a cryptocurrency over the last 20 days. The outer lines form the range or ‘bands’ in which the price is expected to move up or down, and are typically two standard deviations (standard deviation measures the amount of variation/deviation from the mean) from the midline.
A price move towards the upper band indicates strength, while a move toward the lower end of the band indicates weakness. During periods of low volatility (increased price stability, not as many extreme price movements up or down), the Bollinger bands tend to narrow. When the price volatility is high, the bands tend to widen. This can be used to foreshadow certain upcoming trends, as a period of low volatility or narrow bands is usually followed by a period of widening bands, and vice versa.
The bands should contain 88-89% of the price action, which makes a move outside the bands significant
When the price touches or moves outside of the band on either end, it is considered a ‘tag’ and not a trading signal. When the upper band has been breached, it usually represents that the cryptocurrency has been overbought, and will correct. This is usually a good time to sell. When the lower band has been breached, it typically signals that the cryptocurrency has been oversold, which is a good entry point to buy. When new highs are reached outside the band, immediately followed by daily highs inside the band, it typically signals a trend reversal. The same is true on the opposite end.
The bands can be used to determine the strength of a trend and to identify entry and exit points for trading. It is best used as a short term trading indicator, but can provide value for mid- to long term analysis as well. That being said, Bollinger bands are not as useful when used alone and should be used in conjunction with other indicators for trend confirmation. Some other good indicators to use along with Bollinger bands would be the Relative Strength Index (RSI) and Volume to name a few, as you are looking for trend confirmation. When you think a cryptocurrency is bullish, try to confirm your hypothesis by using other technical indicators to confirm the trend. Once you have confirmation, you should have more confidence in placing your trade.
A general rule of thumb is to buy when the price is near the bottom of the Bollinger band and sell when it breaks above the midline or gets close to the upper band. This is not always the case though, which is why it’s best to use other indicators in conjunction with Bollinger bands and an overall trend analysis in order to make the most informed trade decision possible.