Bollinger Bands indicator: How to use
Bollinger Bands is an indicator developed by John Bollinger. It helps to assess market volatility and determine the overbought or oversold levels of the asset.
The Bollinger indicator is a popular technical analysis tool among traders. It consists of three simple moving averages that collect and display the necessary information:
1. Middle band shows the dominant price trend on the timeframe.
2. Upper band SMA 20, shifted two standard deviations up.
3. Lower band SMA 20, shifted two standard deviations down.
By comparing the position of an asset's price relative to the bands, a trader can determine if the price is at relatively high or low price levels in a given time frame.
The distance between SMAs increases during high volatility and decreases when the market stabilizes. If the lines are close together, it means that the low volatility period is almost over and a sharp price move will soon follow. If the bands are far apart, it is considered that the period of high volatility is coming to an end.
The volatility in the cryptocurrency market is much higher than in the traditional asset markets. Therefore, an indicator that takes into account volatility is a useful tool for traders.
How to use Bollinger Bands?
The indicator gives a lot of signals, but keep in mind that they are not always set in stone. During a strong trend, the price can go far beyond the lower or upper bands and stay there for a long time.
The price almost always returns to the central zone between the bands. Therefore, if the price touches the upper line, this is a possible signal to open a short position. If the price touches the lower line, this is usually a signal to open a long position.
Before opening a position, you should always find the signal confirmation by other technical analysis indicators. Usually, the higher the timeframe, the better the bands act as dynamic support and resistance.
Most of the time, the upper and lower bands act as support and resistance. Source - TradingView
If the bands compress too much, it is called a squeeze. Usually, it signals an imminent increase in volatility and a sharp movement up or down. If the asset price is above the upper band, the growth is likely to continue. If it is below the lower one, a fall is most likely to follow.
Squeeze on the Bitcoin chart. Source - TradingView
Bollinger Bands are also used to determine the trend’s strength. If during an uptrend the price touches the lower line, this indicates that the bulls are starting to run out of steam. If during a downtrend, the price goes far from the lower line and touches the upper one, this indicates that the bears are losing strength.
For different trading strategies, different indicator settings are used.
1. Short-term trading: 10-day SMA, bands at 1.5 standard deviations.
2. Medium-term trading: 20-day SMA, bands at 2 standard deviations. This is the indicator’s default setting.
3. Long-term traders use the 50-day SMA and band at 2.5 standard deviations.
Bollinger Bands is not a separate trading system. This is one of the indicators that helps traders assess the situation in the market. According to John Bollinger, his system works best in conjunction with the MACD, RSI, and volume indicator.
