Bollinger Bands: What They Are and How to Use Them in Trading

What Are Bollinger Bands and What Is Their Basic Concept? 

Traders commonly use online tools to assess the market situation and make strategies.

Bollinger Bands (BB) is a technical analysis indicator analyst John Bollinger proposed in the 1980s. The primary purpose of this tool is to display the degree of price fluctuations. When volatility increases, the bands become wider, and when the exchange rate is stable, they become narrower. 

Components of Bollinger Bands 

The structure of the indicator provides three components: 

• The average band (SMA) reflects the average value of the exchange rate for a certain period. 
• The upper band indicates the deviation of the rate above the average values. 
• The lower band reflects the change in value downward from the average values.

In the classic version, the indicator is set up with a period of 20 (minutes, hours, days) and a standard deviation of 2, which determines how far the price usually moves up and down from the average.

Bollinger Bands form a kind of “corridor” on the candlestick chart, inside which the price is most of the time. Deviation of the rate outside the range can indicate the possibility of entering or exiting a position. 

How to Use Bollinger Bands in Trading? 

In stock and other markets working only on weekdays, the standard settings of the indicator (period of 20 SMA) cover about four weeks of trading activity. However, in the crypto market, where trading goes without breaks, it is better to use SMA with parameters 28-30 for a more accurate analysis of the monthly period. This approach allows you to make more precise calculations and improve price forecasting.

Using longer intervals for SMAs can enhance the indicator signals. For example, a period of 100 will provide higher accuracy than a period of 20. However, it is essential to remember that the frequency of signals decreases as the interval increases. The choice of parameters depends on the trader’s goals: short periods are suitable for active trading, and if you need rare but reliable signals, you should set long time intervals. 

Below are a few practical ways to use the indicator in crypto trading. 

Narrowing and widening of the bands 

Bollinger Bands reflect the dynamics of changes in the value of an asset. When they begin to narrow, it signals a decrease in market volatility. Such a phenomenon often portends a sudden and significant price jump, both up and down.  

What to do? Watch for the moment when the bands widen, which may signal that the rate is ready for a strong breakout. 

Band contact 

When the price approaches the upper Bollinger boundary, it often indicates that the asset is overbought, which may herald a price decline. If the chart touches the lower band, it indicates undervaluation and points to possible growth. 

Important! Such signals are most effective in conditions of a weak trend, but touching the bars can only confirm its further development if it is well expressed. 

“Walking” along the bands 

In the conditions of a stable trend, the rate can “hold” near the boundaries. For example, in a rising market, the price chart usually stays near the upper line, and in a falling market — near the lower line. 

What to do? In the case of a bullish trend, wait for a pullback to the middle band to open a buy position, and in the case of a downtrend, use an upward pullback to enter a sell position. 

“W” and “M” patterns 

Characteristic “W” and “M” patterns are sometimes formed on the chart, which help identify a possible trend reversal: 

The “W” pattern usually occurs at the lower boundary of the market and indicates a transition from a downtrend to growth. The rate values approach the lower band, bounce up, and cross the midline. 

The “M” pattern appears at the top of the market and signals a downward reversal. The chart reaches the upper band, declines slightly, rises again but no longer reaches the upper line, and then goes down, breaking the previous low. 

How to use the “W” pattern?   

Example: 

You see that the price has fallen to the lower Bollinger band, bounced, crossed over the middle line, and then fell slightly again but did not reach the lower boundary. If the price breaks the previous high, it is a buy signal.   

How to use the “M” pattern?   

Example: 

The price rose to the upper Bollinger band, bounced down, crossed the SMA, then rose again but failed to reach the boundary. When the rate falls below the previous low, this is a sell signal. 

Bollinger Bands and Market Volatility 

The distance between the Bollinger Bands changes automatically depending on the degree of market volatility: 

• During periods of “calm,” when prices move within a narrow range, the bands move closer together. This indicates insignificant price changes and possible preparation for a strong jump in any direction. Traders often call this phenomenon the “compressed spring effect.” Experienced specialists recommend waiting for the moment when the bands start to diverge, as it can be a signal for the beginning of active rate movement. 
• When the market activity grows, the bands widen, which warns of increased volatility and a substantial jump in value. However, before opening a position, it is essential to ensure that the trend is confirmed with the help of additional indicators. 

Trading Strategies Using Bollinger Bands 

How to include the results of crypto analysis in your trading plan? We offer two options: 

Range trading 

This method is ideal for a low volatility market, when the price moves within the “corridor” outlined by the Bollinger Bands. 

How does it work? 

The upper band of the indicator reflects the resistance level, and the lower band indicates support. 

If the price falls to the lower boundary, traders tend to buy, assuming the asset may be in the oversold zone. 

When the price approaches the upper band, market participants begin to sell, fearing that the asset is overvalued. 

For trading inside the range, experts advise fixing profit as soon as the price reaches the SMA without counting on its further movement to the opposite band. This helps minimize trading risks. 

Trading on breakouts

This strategy is used when the market is preparing for a strong movement, especially after a period of “calm.” 

How does it work? 

When the lines converge, it signals a “calm” in the market, which is often followed by a sharp move. 

A breakout signals a buy/sell, depending on the up/down movement. 

To avoid false signals, professionals confirm a breakout only after as many as three consecutive candlesticks are recorded above the upper or below the lower band, depending on the direction. 

Bollinger Bands and Other Indicators 

Investors who combine the BB indicator with other methods of crypto analysis get more accurate results because this tactic helps filter out false signals. The most popular combinations are described below: 

Relative Strength Indicator (RSI) + BB 

RSI informs whether an asset is overvalued (indicator > 70) or undervalued (< 30). 

Example: 

If the value is at the upper Bollinger Boundary and RSI > 70, it is considered a sell signal. If the value is near the lower band and RSI < 30, it is advisable to open buy trades. 

Volume + BB 

Trading volume helps understand how strong the value movement will be. 

Example: 

If the price breaks the BB line up or down and volumes increase sharply, this can be a confirmation of the breakout. 

MACD + BB 

The MACD indicator analyzes moving average crossovers and divergences between the price and the indicator. 

Example: 

If the price breaks through the upper Bollinger boundary and the MACD lines cross in a bullish direction, this confirms a buy signal. 

Average Directional Movement Index (ADX) + BB 

The ADX indicator helps determine the strength of a trend. 

Example: 

If the rate moves outside the Bollinger Bands and the ADX is above 25, it indicates a strong trend, and the price will continue to move in the same direction. 

Moving averages (MA) + BB 

The indicator already uses the SMA, but additional moving average lines with different intervals are often used to confirm the direction of the rate. 

Example: 

If the price is above the Bollinger Bands SMA and the 50-day SMA, it confirms a bullish trend, and if it is below, it confirms a bearish trend. 

Limitations of Bollinger Bands 

A trading strategy cannot be based only on the Bollinger indicator because it does not show all the data. The obtained conclusions require confirmation and additions. Let’s consider the main limitations: 

1. The Bollinger indicator does not inform the trader in which direction the price will go in the future. It shows only the current volatility. 
2. The price can repeatedly touch the bands in a sideways (flat) market, creating false buy/sell signals. This can lead to wrong decisions and losses. 
3. The effectiveness of the BB indicator is reduced if a trader cannot recognize what phase the market is in (flat or trending). For example, touching the upper band in a strong uptrend does not indicate a reversal but only confirms the continuation of upward movement. 
4. The results of the indicator strongly depend on the moving average period (usually 20). Incorrectly chosen parameters can give distorted signals. 
5. The indicator is based on price only and does not take into account fundamental events or changes in market sentiment. Sudden news can cause movements that are impossible to predict with the help of this tool. 

To protect your capital, analysts advise you to set stop losses outside the band opposite to your entry. This allows you to limit losses if the market moves against you.   

An effective approach to profit-taking is taking profits, which can be set on the SMA or the opposite band. 

Pros and Cons of the Bollinger Bands Indicator 

Let’s first consider the advantages: 

• Identification of trading points: Bollinger Bands help find moments to open or close trades, indicating a possible reversal or continuation of the rate movement in the same direction. 
• Visualization of volatility: The indicator shows the level of activity in the market. 
• Flexibility and simplicity: The parameters can be easily customized for different assets and trading styles, allowing beginners and experienced traders to use the indicator. 

Bollinger Bands also have some disadvantages:  

• False signals: The price can break through the boundaries of the bands but then return to the range, which creates a risk of errors. 
• Limited effectiveness in a sideways market: The indicator signals are less reliable in flat markets. 
• Need for adaptation: Bollinger Bands were initially developed for the stock market, so the effectiveness may vary in other areas, including crypto trading. 

Bollinger Bands are a powerful but not self-sufficient tool. For success, it is important to combine it with other indicators and take into account the overall market situation. Do not risk more than 1%-2% of your deposit in a single trade, even if the signals look reliable. 

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