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Bollinger Band is a popular technical analysis tool used by crypto traders to define high or low on a relative basis. Developed and named after by the US-based technical analyst John Bollinger in the s, this tool has become a popular option for traders trying to predict future market behavior. In essence, Bollinger Band consists of three different lines, where one sits below and one above the asset price.
The third one, called the midline or centerline, is actually a simple moving average SMA , whose value is usually set at 20 i. These two outer lines expand and contract depending on the volatility of the given asset. Markets tend to trade in bullish or bearish trends or ranging and trading sideways. So, one of the reasons the Bollinger Band tool was designed is to monitor the price action more closely, by trading the channel that encompasses the trading activity from both sides.
Bollinger Band shows the level of activity surrounding the asset in question like the cryptocurrencies bitcoin or ethereum. If the price action hits the upper Bollinger Band, the tool suggests that the asset is overbought and that we may see a rotation from the current levels. On the other hand, the tag of the lower Bollinger band signals that the market trades in an oversold environment and we may expect a bounce.
In a strong uptrend, the price tends to trade between the centerline and the upper Bollinger band, and vice versa. In this case, crypto traders see a cross below the centerline as a signal that the trend may be reversing. The two main goals of this indicator are to convey the market message on the volatility and to define high resistance or low support on a relative basis.
A sharp change in the market behavior is likely to lead towards the squeeze breakout. Some crypto traders use this as a signal that the consolidation phase is over and the market is breaking out. As mentioned earlier, there are two generally accepted crypto trading strategies that include the Bollinger Band. One group of crypto traders prefers to use Bollinger Band to define support and resistance lines. Bollinger Bands consist of three lines: the lower band, the middle band, and the upper band.
The middle band is a period simple moving average SMA. The upper and lower bands are drawn on both sides of the SMA line, and the distance between the two is determined by standard deviations. Bollinger Bands are typically charted over so-called periods. Some traders make those periods hours, others prefer a longer-term approach and make those days. However, it doesn't necessarily have to be 20 periods — it is up to the trader what time frame to choose.
It should be also mentioned that many traders will increase the standard deviation when charting more than 20 periods and decrease the deviation when charting less than 20 periods. The trader can also determine how many standard deviations he or she wants the indicator set at. However, many prefer to use two standard deviations from the average, as they are believed to capture around 95 percent of the price movement.
As the upper and lower bands represent standard deviation, it means they are based on price volatility. When the bands contract and lie close together, a period of low volatility is indicated. Conversely, when the distance between the bands expands, an increase in market volatility or price action is found.
If the bands begin to form a slight slope and track almost parallel for an extended period of time, the price will usually be found to swing between the bands as though in a channel. Defined by standard deviation, the bands also establish where the support and resistance levels might be.
The main idea behind Bollinger Bands is that by comparing a stock's position relative to the bands, a trader gets an opportunity to determine whether a stock's price is relatively high or low. If stock prices continuously touch the upper Bollinger Band, the prices are considered to be overbought. Conversely, if they continuously touch the lower band, prices are thought to be oversold.
These, in turn, serve as a buy or sell price signal. Bollinger Bands are among the most reliable and effective trading tools you can possibly choose from. The Bollinger Bands indicator is considered to be infallible, as it always uses volatility to adjust to the current economic environment and price action in real time. Bollinger Bands, used by novices and experts, were invented by John Bollinger — an American financial analyst, author and contributor to the field of technical analysis.
He started developing Bollinger Bands in the early s. Back then, he was involved in options trading, and most of his analytics revolved around volatility. When developing his concept, Bollinger took the Keltner Channel as an underlying basis. His idea was to incorporate volatility standard deviation to make trading bands more adaptive.
He charted a day moving average of the closing price with the bands on both sides, representing doubled standard deviations of the moving average. He found out that it effectively captured around 95 per cent of the variation away from the moving average. Bollinger first introduced the concept to the world on Financial News Network in Bollinger Bands provide traders with many advantages. In markets that tend to be rather volatile, the Bollinger Bands chart can be very useful in determining price pattern, reading the trend strength, timing entries during range markets and finding potential market tops in a dynamic, adaptive manner.
The use of Bollinger Bands is often coupled with other analysis tools, so it can offer an objective view of the markets and act as a key decision zone for various trading strategies. The use of Bollinger Bands varies among traders depending on their overall trading strategies, styles and goals. However, it is important to mention that Bollinger Bands trading is not limited to stock only: options and CFDs traders often successfully utilise this tool for their trading needs.
When using Bollinger Bands, many define the lower and upper bands as price targets. Some buy when the price touches the lower band and exit when the price touches the moving average in the centre of the bands. Others prefer to sell when the price falls below the lower band or buy when price breaks above the upper band.
The overbought and oversold strategy is favoured by many. It relies heavily on Bollinger Bands and depends on the mean reversion of the price. Mean reversion expects that, if the price significantly deviates from the average, it will eventually revert back to the mean price. As we already know, Bollinger Bands identify asset prices that have deviated from the mean. Thus, when the price of the asset breaks below the lower band, a trader can enter a long position seeking the price to revert back to the SMA band.
Conversely, when the price breaks above the upper band, the trader can short the asset betting on a move back to the middle band. Another Bollinger Bands strategy that is relatively simple to implement is known as a squeeze strategy. Squeeze refers to the narrowing of the trading range and implies an impending breakout. It happens when the price is moving aggressively and then suddenly starts shifting sideways in a tight consolidation. A trader can visually identify when the price of an asset is consolidating as the lower and upper bands get closer together on the chart.
It means the volatility of the particular asset has decreased. After a period of consolidation, the price usually tends to make a larger move in either direction, ideally on high volume.