A quick and easy guide to understanding technical analysis and how to use Bollinger Bands. Good for beginners!
What are Bollinger Bands?
Bollinger Bands® is a technical indicator that measures the market’s volatility and provides a large amount of information that is very useful for making decisions to buy and sell crypto assets. It was invented in the 1980s and is now a registered trademark by John Bollinger.
Bollinger bands can tell us the following information:
- Consolidation periods during Bear or Bull markets (when the bands are contracting)
- Periods of impending breakouts with ample volatility (when the bands are expanding)
- Trend continuation or trend reversal resulting from breakouts
- Highs and lows of the prices touching the bands
The Bollinger Bands indicator uses a statistical measure known as the standard deviation to determine where potential overbought or oversold levels might occur. These lines expand or contract according to the market’s volatility or lack thereof.
The SD is a statistical measure that calculates the distribution of data concerning its mean.
Bollinger Bands is best used when overlayed during consolidation (before breakout) which assumes that there’s a normal distribution of data (price).
When external factors like news are introduced to the equation, it increases the uncertainty in the market and the price may start to expand beyond two standard deviations.
How Bollinger Bands Work
It comprises three trending lines, with the middle line set as a Simple Moving Average, usually calculated in 20 days (20 bars in lower time frames), and two outer bands, which are the statistical deviations from the middle line (mean).
The middle line (20SMA) usually crosses above or below the candlesticks. Supplementing the knowledge of Support and Resistance lines (which you can read here), we can now infer the next trend.
Adding the two lines with a standard deviation of two (2) above and below the middle line, we can now see what areas constrict and expand and the price levels with ample support and resistance.
Applying Bollinger Bands in Practice
- When the two outer bands expand, the price of the coin/token starts to deviate and be volatile, which may signal a new trend.
- You can also use the outer bands to investigate if the price will start to bounce off these lines during market consolidation.
- The breakout of the previous range mainly initiates trend phases, materialized by a candlestick outside one of the two outer bands, well above or below recent movements.
- Momentum traders will look for price closes beyond the Bollinger bands to catch breakouts and take advantage of the new trend.
- When candles consistently close above/below the middle line and expand beyond the outer lines, the market enters a period of extreme volatility.
Peaks indicated times of intense speculation and troughs indicated times of low interest in the market, when speculation was not high on people’s agenda.
John Bollinger
Would you apply the Bollinger Bands in your trading strategy? Let us know in the comments below.
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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.
Please conduct due diligence and manage your risks accordingly.
