One challenge new crypto traders face is learning technical indicators to analyze and predict market moves and possible entry and exit positions.
The Bollinger Bands indicator has become one of the most popular go-to indicators among crypto traders, not only because of its simplicity but also because it is among the most versatile indicators, offering a lot of useful information. For this reason, we will give you more insight into 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: the upper, middle, and lower. Traders use the bands to analyze price action to determine what is going on 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 upper band is set at two standard deviations above the middle line, while the lower band is set at two standard deviations below the middle.
The bands respond to market prices—they move when the market price moves. Market information is obtained by observing price action in relation to the bands’ movement. The trader then employs the information obtained to make various trading decisions.
6 Ways You Can Use Bollinger Bands in Crypto
Let’s look at how different structures in the Bollinger Bands Indicator can be interpreted, including how you can use it to determine support and resistance, market volatility, overbought and oversold levels, the market trend, and how they can be traded.
1. Support and Resistance
When the price reaches the upper band, traders expect it to form a resistance, while the lower band serves as a support. Depending on the market’s direction, the middle band can also serve as a support or resistance level. If the price is below the middle band, traders start to seek price resistance at the middle band. However, if the price is above the middle band, then it can serve as support.
2. Checking Market Volatility
The contraction or expansion of the trading bands signals volatility and potential price movement. When the bands (the upper and lower bands) move away from the middle line, it signifies that the market is volatile and an explosive move is about to start or is ongoing. When they become tighter, the market trend is lower, and the ongoing 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 drops below the lower band. When the market is overbought, traders start to look for ways to sell, and they start to look for ways to buy when the market is oversold.
4. Determining Trends (Uptrends and Downtrends)
Crypto traders can use Bollinger bands to predict if the price of a coin will continue in an upward or downward trend. For instance, when the price continuously hits the upper band, it indicates a strong uptrend. In addition, if the price reverses and doesn’t break below the middle band before returning to the upper band, the uptrend is strong. However, if it breaks below the uptrend and moves to 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 retraces to the middle and then moves back to the lower band, you can say 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
A squeeze occurs when the upper and lower bands move near the price. At this point, the market volatility is low, and the price is moving within a close range. What you can do here is wait for a break-out and then follow the market’s direction. If the price breaks the upper band, it is likely to continue up, but if it breaks the lower band, it is likely to continue downward. That way, you can follow the trend that is starting.
6. Bollinger Bounce
Bollinger bounce is used for trend reversal, and just like its name implies, when the price touches one of the bands, it bounces off it. The bands, in this case, act as dynamic support and resistance. 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 higher band, they look for selling opportunities.
Every Trader 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 alter the default setting to accommodate their strategies and trading styles. For example, the middle band simple moving average is a 20-day simple moving average, which provides information based on the last 20 candlesticks. If you need more long-term information, you can choose a longer period.
Bollinger Bands only serve as an indicator of recent market price action. They do not consider many other factors like fundamental analysis, market sentiment, and other factors that can affect the general market price. For this reason, you cannot depend on it to be the sole determinant of your trading decisions.
Like every other indicator, Bollinger Bands work best when combined with other tools and indicators, as you have more confluences and confirmations for any trade you want to execute.
Bollinger Bands Are Useful for Beginners and Experts
Although every strategy has drawbacks, Bollinger bands have been useful to many traders. They are also very popular among beginner and expert traders who use indicators. Add the indicator to your chart to see how it works and how the price moves with respect to the three bands. As you understand the indicator, you can add it to your list of useful indicators and even alter some of the default settings to tailor it to your needs.
