Crypto Strategy: Bollinger Bands (BBs)
Last Update: October 28th, 2021
Created in the 1980s by market technician John Bollinger, Bollinger Bands (BBs) are one of the most frequently used indicators in the world. Implemented by legions of forex, crypto, futures, and stock traders, Bollinger Bands offer insight into a market’s relative volatility and overall state.
In the cryptocurrency markets, Bollinger Bands, commonly abbreviated to “BBs,” may be used to quantify a coin’s past and present pricing volatility. Structurally, BBs are composed of two trendlines that enclose a simple moving average (SMA). Known as the “upper” and “lower” bands, these levels are plotted two standard deviations from the SMA or “midpoint.” Ultimately, BBs provide the user with a visual representation of volatility relative to a periodic norm.
How Does The Bollinger Band Strategy Work?
Bollinger Bands are practical tools for market entry, trade management, and strategic development. One of the great things about the indicator is that combining Bollinger Bands with other strategies is readily accomplished. Separate indicators such as Exponential Moving Averages (EMA), Stochastics or the Relative Strength Index (RSI) may be routinely applied.
For active traders, BBs are simple to use. All calculations are performed automatically by the software trading suite and plotted graphically as a chart overlay. Below are the key steps in applying the Bollinger Band strategy for cryptos:
- Configure: Before using, the BBs must be configured by the trader. This means that ideal standard deviations and SMA settings need to be chosen. Typically, a standard deviation of 2.0 and SMA period of 20 is used. However, these values are fully customisable.
- Trend: For trend trading, the upper and lower BBs are exceedingly important. In a trending market, the distance between the BBs is wide. If a price bar closes outside of an upper or lower band, the periodic trend is expected to continue. If a price bar closes inside of the BBs, price is expected to move sideways or reverse course.
- Rotational Markets: In the event that the upper and lower BBs are close together, a rotational or reversion-to-the-mean strategy is advised.
How Is The Bollinger Band Strategy Used In Crypto?
In the trade of cryptocurrencies, Bollinger Bands are used primarily to identify market state. The beauty of BBs is that they furnish the user with a straightforward representation of price action. Accordingly, there are two elements of this strategy to be aware of in regards to market state:
- Consolidation: In the event that the upper and lower BBs are close together or “tight,” a market is in consolidation. This means that periodic trading ranges are small, price action is choppy, and participation is balanced. Under this scenario, the BBs are viewed as viable support and resistance levels.
- Trending: When the upper and lower BBs are far apart, a market is exhibiting heightened volatility and likely trending. Prices are moving directionally, extending the periodic trading range. In trending crypto markets, BBs act as directional indicators, not necessarily support or resistance levels.
The weekly chart for Ethereum (ETH) below gives us a good look at how BBs function in real time. Under this scenario, the ETH/USD is in the midst of an extended bullish trend. As you can see, the upper and lower BBs are extremely wide and near parallel. If the current weekly bar closes above the upper BB, a long trade is advised.
Things To Watch For When Trading Crypto With Bollinger Bands
Like all indicators, there are certain things to be aware of when trading cryptos with BBs. Here’s a quick look at three key elements:
- Market State: Perhaps the most important aspect of BBs is that they are designed to quantify market state. In the event that a market is trending, the upper or lower BB isn’t a reliable support or resistance level, but a directional indicator. For instance, let’s say that the distance between the upper and lower BB is wide and the slope of each is negative and growing steeper. According to this scenario, the cryptocurrency in question is in the midst of a heavy downward trend. The lower BB should not be viewed as a potential support level; instead, it functions better as an indicator of how strong volatility and the bearish price action is. Before considering a long trade, the current price bar must close above the lower band and suggest that price action is becoming exhausted.
- Periodicity: As with all chart-based technical indicators, the periodicity of the pricing chart is critical to the study. The term periodicity refers to the chart’s chosen period or duration. With Bollinger Bands, it’s important to make sure that your periodicity compliments your trading strategy. To illustrate, assume that you are a short-term Bitcoin scalper that is looking to make small profits on rapid pricing moves. In this case, it’s a good idea to choose a short-term intraday period for your BBs, such as a 1 or 5-minute chart. Upon doing so, you will be able to judge market state on a useful timeframe and craft timely, relevant trading decisions. However, for other strategies such as day or swing trading, greater periodicities are more appropriate. It’s important to always make sure that your BBs are being applied to a timeframe complimentary to your trading strategy!
- Trend vs Rotational Trading: Bollinger Bands are a unique indicator in that they function well in both trending and rotational markets. The functionality of the indicator is equally useful in all kinds of crypto trading conditions; all that is needed is a viable means of aligning risk to reward to generate consistent profits. As a general rule of thumb, trend trades are best approached with at least a 1:3 risk vs reward ratio. In this way, it becomes possible to fully capitalise on directional price moves, something very common in cryptocurrencies. For rotational markets, a more conservative risk vs reward in the neighborhood of 1:1 or 1:2 is advised. Remember, the profit potential of rotational trades are far less than trend plays. When using BBs to trade consolidating markets, orders are placed from the upper or lower BB against price action. Under this strategy, the maximum profit target is the midpoint or SMA; a location not too distant in a rotational market.
Predicting Crypto Prices With Bollinger Bands
Crypto price prediction is a difficult business and far from a true science. Nonetheless, BBs are useful in projecting where a market is heading and how it may get there. One way to forecast future crypto price levels using Bollinger Bands is to observe volatility. If the bands are wide open and have formidable slopes, it’s probable that the prevailing trend will continue. If the bands tighten and flatten out, price is likely to stay near current levels for some time. Although these guidelines do not define precise price points, they may be used to identify periodic ranges for any crypto being traded.
Pros And Cons Of Bollinger Band Strategies
|
Pros |
Cons |
|
Works well in crypto trading when used with other technical indicators |
Not designed for identifying precise cryptocurrency market entry and exit points |
|
Provides the cryptocurrency trader with a great view of market state |
Can produce false crypto buy and sell signals |
|
User-friendly, may be easily applied to any crypto chart |
It may be a challenge to select the appropriate crypto chart periodicity |
Common Mistakes To Avoid When Using Bollinger Bands
Unfortunately, BBs aren’t the holy grail to becoming a profitable crypto trader. Here are three mistakes commonly made by practitioners of the strategy:
- Lack A Plan: Without solid guidelines for risk and money management, BB traders often sustain big losses. It’s important to implement BBs as part of a comprehensive trading plan, not on a standalone basis.
- Use Too Much Leverage: Bollinger Bands aren’t infallible! Many traders apply too much leverage on a single or series of trades. This can lead to huge losses and rapidly blowing out the trading account.
- Ignore Periodicity: It’s imperative that the duration of the price chart reflects the strategy. If not, the Bollinger Bands’ representation of market state is largely useless. Compare apples to apples, not apples to oranges!
Get Started
Bollinger Bands are a great way to begin integrating technical analysis into your trading plan. BBs are user-friendly and can provide valuable insight into a cryptocurrency’s behavior. If you’re ready to realize the potential of Bollinger Bands in crypto trading, add BBs to your price charts and get started!
About the author
Skerdian Meta Lead Analyst. Skerdian is a professional Forex trader and a market analyst. He has been actively engaged in market analysis for the past 11 years. Before becoming our head analyst, Skerdian served as a trader and market analyst in Saxo Bank's local branch, Aksioner. Skerdian specialized in experimenting with developing models and hands-on trading. Skerdian has a masters degree in finance and investment.
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