Bollinger Bands are a technical analysis tool comprising trading bands or envelopes. It’s a statistical chart plotting price or volatility over time based on the formula propounded by John Bollinger in the 1980s. The price is a moving average (the middle band). The upper and lower bands running along with the middle band answer the question as to whether prices are high or low on a relative basis. Bollinger Bands work best when the middle band reflects the intermediate-term trend, so that trend information is combined with relative price level data.
Related articles
The mathematics behind the three curves can be summarized as follows:
- N-period moving average (MA), the middle one
- Upper band at K times an N-period standard deviation above the moving average (MA + Kσ)
- Lower band at K times an N-period standard deviation below the moving average (MA − Kσ)
Typical values for N and K are 20 days and 2, respectively. In place of a simple moving average, you may use other averages as well.
Application of Bollinger Bands in Crypto Trading
Knowing Overbought and Oversold
A high upward deviation (more vertical distance) from the middle reflects an overbought situation, while a downward deviation reflects an oversold situation. When a crypto asset is oversold, its price tends to decline and when it’s overbought, its price moves up. Depending upon the graph, you can strategically buy or sell your asset to maximize your asset. However, there is a caveat, when there is exceptional deviation, you should be alert. Such situations often surface when whales or big traders are involved in the trading. Such changes are often short-lived, and the prices may retrace.
Knowing the Trend Indicators
Understanding the trend is helpful if you are investing in the derivatives or futures market. Bollinger Bands spontaneously react to price changes as though created in live time. Contraction and expansion in the curve due to price action are noticeable. If the price has a lot of momentum, the upper or lower curve is more likely to stay away from the mean.
Some experts recommend adding another moving average such as the 50 EMA (Exponential Moving Average) to plot strong trends. An EMA reacts more significantly to recent price changes than an average or simple moving average (SMA), which applies an equal weight to all observations in the period.
When the previous three bands come under the 50-day EMA, day trading or one with short tenure would be helpful. Expect a profitable outcome over a long period, when the three bands transcend the 50 EMA.
Taking Advantage of Scalping
If you target at benefiting from small price changes of the crypto assets, i.e., scalping, Bollinger Bands are your go-to technical analysis tool. Scaling is often practiced by day traders. It demands creating a strict exit strategy. Remember, one large loss can neutralize multiple minor gains. Use Bollinger Bands, to know the oversold or overbought conditions and respond accordingly to benefit from the price change.
If the price of a cryptocurrency breaks below the lower band of the Bollinger Bands, prices have perhaps fallen too much and are due to bounce. Conversely, when the price breaks above the upper band, the market is perhaps overbought and due for a pullback. As in the above, you may add a 50-day EMA band as well to be on alert about any strong trend.
