What are Bollinger Bands
Bollinger Bands (Bollinger Bands or BB) is a technical analysis indicator that aims to determine the trend of a particular cryptocurrency, as well as measuring its volatility. The term was introduced into practice by John A. Bollinger (John A.. Bollinger) in the late 1980s and early 1990s.
Purely visually, Bollinger Bands represent a channel that widens or narrows depending on changes in the price of a particular cryptocurrency. It is the width of the channel that is a reflection of the volatility that is present at a particular moment in the market.
How do you construct Bollinger Bands?
Building Bollinger Bands
The indicator represents three lines. Average = nothing other than a regular moving average. That’s the way it’s set up originally by the creator. In some terminals it is possible to replace it with exponential (EMA) or weighted (WMA) moving average.. That said, the effectiveness of the replacement is quite debatable.
Since we have a moving average, then it needs a period for which it will be calculated for. Bollinger used a 20-day interval, which is set by default in settings. And further everyone can experiment and set a shorter or longer time interval.. It all depends on your trading style and the specific cryptocurrency you re trading.
The top and bottom lines represent the same moving average, just shifted by a few square (standard) deviations. Bollinger used a parameter equal to 2. True, he wrote this in relation to the stock market: in the 80s and early 90s there were no cryptocurrencies yet. Perhaps, with consideration of volatility, three or five standard deviations would be more appropriate for digital assets. Again again, it’s all individualized.
Calculating moving averages and standard deviations manually does not make sense. In any, even the most ordinary, trading terminal this is done automatically. All you have to do is set the parameters required for your trading system.
How do I use Bollinger Bands?
Using Bollinger Bands
The application of the indicator will be different for sideways and trend movement. In the first case, the price of cryptocurrency will predominantly stay within the channel (beyond the boundaries of the moving average shifted by several deviations). In this case, the tactic is very simple: when the price reaches the lower band – buy. When reaching the upper – sell. That said, there is virtually no slope to all three lines.
The second situation is a trend situation. It is accompanied by channel widening and increase in the slope angle of the median moving average. When trending, price can often rise above the upper boundary of the Bollinger Bands (in the case of a bullish trend) or below the lower boundary (in the case of a bearish trend). The trade in this case will be built from the median strip. If we have a bullish trend, it is a support level, and every time the price drops to it, we can buy it. The reverse is true for a bearish trend. The median band is a resistance level. Every time the price of the cryptocurrency reaches it – you can sell.
When the trend ends, something like a sideways trend is usually formed again, and the Bollinger Bands narrow.
Let’s look at some typical examples. The cryptocurrency Ripple (XRP) has a flat (sideways movement) in May-July 2023. Accordingly, it was possible to buy when the lower band was broken and sell when the upper band was broken. In the figure below, the arrows mark the moments when trades could be executed.
Source: tradingview.com
Now let’s look at trend formation. Let’s take the bitcoin situation in January 2023 as an example. A kind of sideways trend has been observed since the end of November. On the 10th, the price goes beyond the upper boundary, but there is no channel extension as such there yet. But on the 11th both factors coincided and it was possible to buy BTC. As you can see from the chart, it was quite feasible to earn about 40% on the trade going forward.
Source: tradingview.com
John Bollinger paid special attention to W- and M-shaped formations. Let’s take a look at how this works in cryptocurrency.
W and M models
These are two reversal patterns. The W-shape is a bullish signal. It appears when we reach local lows twice after a decline and then begin to rise. The M-shaped pattern is the bearish opposite of the W-shaped pattern. Its occurrence is accompanied by a double achievement of local highs, after which a reversal or a sideways transition begins.
Bollinger believed that classical models of this type are obtained when the first extremum is outside the bands and the second extremum is within the channel;
Litecoin has a similar situation in February 2023. Then, after the growth on February 1, the price went outside the Bollinger Bands, and on February 16 remained inside the channel. After that, the decline began.
Source: tradingview.com
While popular, Bollinger Bands have a number of downsides.
Disadvantages of Bollinger Bands
The first disadvantage is the subjectivity of evaluation. The perfect pictures that Bollinger describes are extremely rare. Moreover, they are often only available ex post facto. A lot will depend on the trader when interpreting specific signals. Some will decide that the channel is narrowing or widening, for example, while for others it will not be a signal at all.
The second thing to note is that Bollinger Bands do not give clear entry points. This is generally intertwined with the first point. Bollinger Bands are a kind of statistical benchmark that covers 95% of all prices of a particular instrument. The trader will have to interpret it on his own. Ideally – combine this indicator with other tools of technical and fundamental analysis.
The third disadvantage is that you will have to customize Bollinger Bands for yourself. Those default settings may not be appropriate for your particular cryptocurrency and your trading style. To find the optimum, you’ll likely have to hit a few bumps.
Conclusion: Bollinger Bands are a tool for measuring price volatility and trend detection in cryptocurrency. Successful use depends on the fine-tuning and trading style of the individual trader.
This material and the information in it does not constitute personalized or other investment advice. Editorial opinion may not coincide with the opinions of the author, analytical portals and experts.