One of the challenges that new crypto traders face is learning technical indicators to analyze and predict market movements and possible entry and exit positions.
The Bollinger Bands indicator has become one of the most popular benchmark indicators among crypto traders, not only because of its simplicity, but also because it is among the most versatile indicators, offering many useful information. For this reason, we will give you more information about how the Bollinger Bands indicator works, how to use it and some of its limitations.
What is the Bollinger Bands Indicator?
The Bollinger Bands indicator reveals market trends and volatility and identifies overbought and oversold market conditions. It consists of three bands: upper, middle and lower. Traders use bands to analyze price action to determine what is happening in the market. John Bollinger developed this indicator in the 1980s, and it has since been used in different financial markets, including the crypto market.
How do Bollinger Bands work?
As it was mentioned earlier, the technical indicator consists of three bands. The middle band is a 20-day simple moving average (SMA). The top band is set two standard deviations above the middle line, while the bottom band is set two standard deviations below the middle.
Bands react to market prices – they move when the market price moves. Market information is obtained by observing the price action relative to the movement of the bands. The trader then uses the obtained information to make various trading decisions.
6 Ways to Use Bollinger Bands in Crypto
Let’s see how different structures of the Bollinger Bands indicator can be interpreted, including how you can use it to determine support and resistance, market volatility, overbought and oversold levels, market trend and how they can be traded.
1. Support and Resistance
When the price reaches the upper band, traders expect it to form resistance, while the lower band acts as support. Depending on the direction of the market, the mid band can also serve as a support or resistance level. If the price is below the middle band, traders start looking for price resistance at the middle band. However, if the price is above the middle band, then it can act as support.
2. Checking market volatility
The contraction or expansion of the trading bands signal volatility and potential price movement. When the bands (the upper and lower bands) move away from the middle line, it means the market is volatile and an explosive move is about to begin or is underway. When they tighten, the market trend is down and the current trend may be coming to an end.
3. Determine overbought and oversold levels
A market is overbought when the price moves above the upper band, while it becomes oversold if it falls below the lower band. When the market is overbought, traders start looking for ways to sell, and they start looking for ways to buy when the market is oversold.
4. Determination of trends (uptrends and downtrends)
Crypto traders can use Bollinger Bands to predict whether a coin’s price will continue in an upward or downward trend. For example, when the price continuously reaches the upper band, it indicates a strong uptrend. Also, if the price reverses and does not cross below the middle band before returning to the upper band, the uptrend is strong. However, if it breaks below the uptrend and moves towards the lower band, it is a sign that the uptrend is weakening and the crypto price may start to reverse.
On the other hand, if the price continues to touch the lower band, it shows that the downtrend is strong. If the price returns to the middle and then returns to the lower band, you can tell that the trend is still strong. However, when it breaks above the middle line and moves to the upper band, the trend may become weak and a reversal may be imminent.
5. Bollinger Squeeze
Compression occurs when the upper and lower bands approach the price. At this point, the market volatility is low and the price is moving in a tight range. What you can do here is wait for a breakout and then follow the direction of the market. If the price breaks the upper band, it is likely to continue rising, but if it breaks the lower band, it is likely to continue falling. This way you can follow the trend that is starting.
6. Bollinger Bounce
Bollinger bounce is used for trend reversal, and as the name suggests, when price touches one of the bands, it bounces off it. The bands, in this case, act as dynamic support and resistance. The Bollinger bounce works well in a consolidating market. When the price bounces off the lower band, traders look for buying opportunities, and when it bounces off the upper band, they look for selling opportunities.
Each merchant determines how to use the information
Although there are some similarities in how Bollinger Bands information is interpreted, each trader has their own approach.
A trader’s strategy and plan usually inform their unique style. Some traders modify the default setting to suit their trading strategies and styles. For example, the simple moving average of the middle band is a 20-day simple moving average, which provides information based on the last 20 candlesticks. If you need longer term information, you can choose a longer period.
Bollinger Bands only serve as an indicator of recent market price action. They do not take into account many other factors such as fundamental analysis, market sentiment, and other factors that can affect the overall market price. For this reason, you cannot rely on it to be the sole determinant of your trading decisions.
Like all other indicators, Bollinger Bands work best when combined with other tools and indicators because you have more confluences and confirmations for any trade you want to execute.
Bollinger bands are useful for beginners and experts
Although each strategy has drawbacks, Bollinger Bands have been useful to many traders. They are also very popular among novice and expert traders who use indicators. Add the indicator to your chart to see how it works and how the price moves against the three bands. As you understand the indicator, you can add it to your list of useful indicators and even change some of the default settings to suit your needs.