For newer cryptocurrency traders, learning how to successfully time market entries and exits is a fundamental challenge. It’s also often a difficult one, given the considerable volatility of the market. Technical trading tools help level the playing field, giving traders access to indicators that can help identify developing market trends and opportunities.
One of the most popular and useful of these indicators are Bollinger Bands. To help you learn more about this indicator and its trading strategies, let’s take a closer look at how to read Bollinger Bands and an applicable trading strategy to go along with it.
Bollinger Bands Meaning
The Bollinger Bands (BB) were created in the early 1980s by financial analyst and trader John Bollinger. They are broadly used as an instrument for technical analysis (TA). Basically, the Bollinger Bands work as an oscillator measurer. It indicates whETHer the market has high or low volatility, as well as overbought or oversold conditions.
How Do Bollinger Bands Work?
The main idea behind the BB indicator is to highlight how prices are dispersed around an average value. More specifically, it is composed of an upper band, a lower band, and a middle moving average line (also known as the middle band). The two sidelong bands react to the market price action, expanding when the volatility is high (moving away from the middle line) and contracting when volatility is low (moving towards the middle line).
How to Read Bollinger Bands
There are a few basic ways of reading and interpreting the information provided by the BB indicator. For instance, imagine that the price of an asset moves from below the middle line all the way up to the upper band, surpassing it. This would indicate a potential overbought condition. The same reading logic applies to the opposite side that may be indicative of oversold conditions. The upper and lower bands may also suggest potential support and resistance levels, in which the price is likely to bounce.
Other than that, the movement of the upper and lower bands in relation to the middle line is a very important factor of the BB indicator. The expansion and contraction of the bands may come handy when traders and chartists are trying to predict the next periods of market volatility (or lack thereof).
For example, if the volatility starts increasing, the bands will expand and move away from the middle line. In contrast, if the market volatility decreases, the bands will contract and move towards the middle.
Bollinger Bands Strategy
A common way traders utilize Bollinger Bands is to trade breakouts. This is done by executing a trade in the direction that the price breaches the band. If the price breaches the top band, enter a long position, and if price breaches the lower band, enter a short. This is best executed in tandem with the bands narrowing, which could be a good signal that the market is readying itself for an explosive move.
A simple strategy would look somETHing like this:
- Wait for the price to reach the top (bottom band). Execute a long (short) position when it does.
- Use a trailing stop with the 20 MA as stop-price. Move the stop every time the MA shifts.
- Exit the trade only when price re-touches the 20 MA.
Using Bollinger Bands for breakout trades on Bitcoin or other cryptocurrencies is recommended over alternate strategies like trading mean reversion as cryptocurrencies are extremely volatile and tend to trend for prolonged periods. However, still do your own research before trading!
Closing Thoughts
Bollinger Bands are a cornerstone technical trading tool used by vast numbers of traders every day to identify developing trends and opportunities in the cryptocurrency market. Now that you have a basic understanding of how to read Bollinger Bands, they can help you determine whETHer a digital asset is overbought or oversold, and inform your trading decisions accordingly.
