During a recent price analysis article of Bitcoin, Ethereum, Ethereum Classic and Binance Coin I used Bollinger Bands as one of my key indicators for identifying market trends. For newer cryptocurrency traders, one of the first fundamental challenges is learning how to successfully find well timed market entries and exits. It is something even the most experienced crypto traders struggle with, simply due to the considerable volatility of the market.
One popular technical trading strategy is using Bollinger Bands to spot developing market trends and opportunities for making a profit. Let's learn about the ideas behind Bollinger Bands and how we can implement them into our cryptocurrency trading strategies.
What is a Bollinger Band?
At its core, the Bollinger Bands is a tool that works very much like the Stochastic Oscillator as they both help traders visualize overbought or oversold conditions. On a chart a Bollinger Band is defined by a set of lines, the moving average of a crypto asset's price is plotted and then this middle line is bracketed by an upper and lower line. These lines are set two standard deviations apart, which is a mathematical formula that estimates how much the cryptocurrencies price can vary from its current value.
Essentially, much like any cryptocurrency indicator tool they are used by crypto traders to spot ongoing market trends and adapt their trading strategies around potential price trend reversals.
How to read a Bollinger Band chart?
There are several ways to implement Bollinger Bands into your trading strategy, and many traders use them differently. First let's look at what the lines are actually telling you on a chart. When the price of a cryptocurrency or token asset is touching the lower band, this would be considered to be oversold. And when the price reaches the upper band then the market is showing overbought conditions.
Here is an example looking at recent BTC / USD trading:
- Blue Circle: When an asset is trading sideways, look how narrow the Bollinger Band is this means there is less chance of any big price swings happening. And then you see it becomes even narrower, this is known as The Squeeze and most traders believe it indicates an upcoming period of increased volatility. When the Bollinger Band is wide open, then the market is much more volatile.
- Green Arrow: Note how when the market trend is bullish the price is moving with the upper band.
- Red Arrow: Note how when the market trend is bearish the price is moving with the lower band.
- Middle SMA line: Note how when the market conditions change the asset's price is crossing over or under the middle 20-day SMA line.
- Breakouts: Nearly 90% of the price action happens between the upper and lower bands. Any price breakout above or below the bands should be considered a major event, but one mistake traders make is that such a breakout is not a concrete signal to buy or sell. So bear in mind that breakouts do not necessarily confirm the direction of future price movements.
How to use Bollinger Bands in crypto trading?
Many traders set their own set of rules they have created from the experience of trading an asset over a period of time. You should create your strategy with the notion that the upper and lower bands should be seen as price targets. Therefore, the key part of being able to profit from identifying a Bollinger Squeeze, is to determine if the asset's price will move into a bullish or bearish trend. A good way to confirm a market trend is by combining Bollinger Bands with other technical indicators, such as the Relative Strength Index (RSI).
If both indicators are showing you the cryptocurrency asset is oversold then you could consider this a buy signal. In this scenario, a popular strategy traders will use is to see the lower band as your entry point and to exit once the price has crossed over the middle SMA line.
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