Mastering Bollinger Bands: Strategy and Key Concepts Explained

Intro

Developed by John Bollinger in the 1980s, the Bollinger Bands indicator was designed to measure volatility in the financial markets. For crypto markets, this indicator is a first-class tool as cryptocurrencies are highly driven by overleveraged positions and large liquidity.

Behind this technical indicator, there is a mathematical development that makes it highly reliable. However, it is not exempt from mistakes and tricky signals. 

In this article, we will explore the core aspects of the Bollinger Bands, and how to use their signals.

What Is Bollinger Bands Indicator

Bollinger bands are a recognized indicator that follows the price changes of an asset based on volatility measurements. Composed of 2 bands and one moving average, this indicator evaluates and gives deep insights into market directions within a specific price range.

While the price of a crypto asset can move sideways or in trending directions, Bollinger Bands gauges it in a range of expansion and contraction that suggests how volatile the market is and how far the price is moving out from its average point.

For a better understanding, let’s break down the composition of Bollinger Bands:

• Upper band: A line corresponding to an exact number of standard deviations above the middle band.
• Middle band: This is a Simple Moving Average (SMA) representing the average price movement over a period, like the SMA of 20 days.
• Bollinger Bands, like other indicators, can indicate overbought and oversold conditions.
• Bollinger Bands is highly suitable for swing trading, addressing significant volatile conditions across higher timeframes.
• Squeeze breakouts is a popular concept among traders using the indicator for price rallies breaking through the upper or lower band. Lower band: A line corresponding to an exact number of standard deviations below the middle band.

Relevant aspects

• Bollinger Bands, like other indicators, can indicate overbought and oversold conditions.
• Bollinger Bands is highly suitable for swing trading, addressing significant volatile conditions across higher timeframes.
• Squeeze breakouts is a popular concept among traders using the indicator for price rallies breaking through the upper or lower band.
• During ranging markets, the bands can act as repetitive reversal points as price bounces between either side, making the Bollinger Bands a distinguished indicator for this type of market.

How to use Bollinger Bands

The key to reading the behavior of the bands is based on evaluating their correlation with market volatility. The indications of this technical tool lie in the expansion and contractions of its bands.

How exactly do those bands work? To answer that question, take a look at the following classification.

Bands Expansion

When the bands widen for the upper and lower sides, the market is facing increasing volatility. This could be interpreted as a trend strengthening, but depending on the market context, something more could be expected.

Let’s see two scenarios:

• Breakout: The price breaking decisively through the upper band, will indicate a strong uptrend movement. Otherwise, breaking through the lower band will signal a downtrend movement.
• Expansion on support and resistance: Bands widening on significant support or resistance levels could indicate a false breakout.

Consider confirmation from other indicators when bands expand after a consolidation phase, it can indicate increased market uncertainty.

Bands Contraction

Bands contraction represents low volatility. In this scenario, traders might expect:

• Consolidation: The price consolidating during a notable period may precede a breakout in either direction.
• Continuation: Band contraction during a remarkable trend might indicate market determination for that trend. However, be aware of a strong squeeze, it can precede a breakout and a reversal in the price direction.

Overview of Volatility in Crypto Markets

The crypto market is well known for its high volatility, an attractive characteristic for some traders with high-risk tolerance. Bollinger Bands can help risky traders take advantage of this market condition

Adapting to Market Conditions: The bands widen during volatile periods and contract during calmer periods.

• Identifying Potential Reversals: When the price reaches the Bollinger Bands®, it might be nearing an overbought or oversold state, potentially indicating a reversal. However, confirmation from other indicators is crucial.

Analyzing Crypto Markets with Bollinger Bands

As mentioned, analyzing the market with Bollinger Bands can offer substantial information about price volatility. Here is how to use this indicator properly:

• Spotting Overbought/Oversold: Even though this is not its principal use, a market quoting close to the upper or lower band could suggest exhausting conditions. Combining Bollinger Bands with another indicator like Stochastic RSI might help get more accurate signals.
• Reversing with Bollinger Bounce: Convenient for swing trading, this approach looks for moments when the price gets to the upper or lower band, expecting a reversing move toward the middle band.
• Breakout of Bollinger Squeeze: Prolonged periods of contraction followed by a breakout through the upper or lower band can signal a potential price rally and entry point for swing trading.

Overview of popular techniques

Among the various uses, Bollinger Bands can offer advanced Volume readings that strengthen the signals, for example:

• Low volume on Breakout Squeeze: A price breakout with low volume could be expected to be a weak move and a potential false breakout.
• Low volume on Breakout Squeeze:  A price breakout with high volume may indicate a strong move and a potential trend continuation.
• Bollinger Bands for Day Trading: Day traders can use this indicator under the Double Bollinger Band technique to find entries with ease. This method adds a layer of confirmation using similar settings for both instances of the indicator. The first uses two standard deviations, and the second uses one standard deviation.
• Bollinger Bands for Swing Trading: The most used approaches by swing traders are reversals and ranging markets. Swing traders can expect meaningful breakouts after a range. Also, swing trading opportunities can emerge from oversold/overbought markets in the form of price reversal points.

Conclusion and Call to Action

Volatility plays a major role in financial markets, but especially in crypto markets. Bollinger Bands has emerged as a distinguished option to address ranging markets, breakouts, and reversal opportunities. It can also serve as a reference for overbought and oversold levels using RSI. Using volume traders can enhance their performance by filtering signals.

In Altrady you can continue studying the Bollinger Bands and even start testing the indicator through a free trial account.