How to use Bollinger Bands to Gauge Crypto Trends
Cryptocurrency investments are always risky. However, they can end up being a very lucrative pursuit if they are well executed. Cryptocurrency volatility has led to the development of more advanced trading strategies to tackle market volatility. Crypto trading involves speculating market price movements. However, many traders fail due to a lack of knowledge of what strategies to use to track price movements.
The question of “what are the best strategies to use” points us to Bollinger bands. Bollinger bands are one of the most actively used technical indicators by crypto traders. Crypto traders use these bands to measure volatility and look for entry and exit points.
Understanding Bollinger Bands
Bollinger bands were developed by a trading veteran, John Bollinger, in 1983. This strategy has a set of rules to follow. The bands consist of a set of three lines plotted over the prices of the assets. The middle line is a simple moving average, while the upper and lower bands enable one to identify whether the price of an asset is relatively high or low.
Traders consider the prices to be relatively high when the price is near the upper band, and if the price is nearer the lower band, it is considered relatively low. The upper and lower band values are equal to two times the standard deviation of the asset’s price history. The middle band is the same as a 20-period moving average but can be modified.
Under certain conditions, Bollinger bands have a way to detect oversold and overbought areas about the moving average. This technical indicator does not always signal a trend reversal but can detect a trend continuation pattern. A strong signal continuation of the trend is achieved if the price surpasses the upper band or falls below the lower band.
The bands are effective technical analysis indicators. However, just like any other indicator, they, too, have their limitations. One of these bands’ limitations is that they are based on volatility; therefore, they react to price moves. So anyone may ask, what’s the best time to use Bollinger bands? Well, there is no specific time. It depends on the trader’s trading style and approach.
Strategies of Using Bollinger Bands
Since Bollinger bands provide reversal and continuation signals, let’s review some of the strategies that use these features.
1. Bollinger Bounce
Crypto traders consider Bollinger bounce as the most simple strategy for trading cryptocurrency using Bollinger bands. Bollinger bounce is a reversal strategy where traders look for a buy position when the price action touches the lower band and when an oscillator is positive.
When price action touches the upper band, and the oscillator is negative, traders sell their positions. Sometimes, the price may break above the upper band and fail to come back; then, it is time to stop trading the Bollinger bounce. It’s always crucial for traders to set stop loss levels near the entry point.
2. Bollinger Squeeze
The squeeze allows traders to identify and trade the breakout at the trend’s beginning. The squeeze is the central part of Bollinger bands. When bands come near each other, they constrict the moving average hence the name squeeze. A squeeze shows low volatility, signaling traders there is a potential for future increase volatility and possible trading opportunities.
In this strategy, the wider apart the bands move, the more chances of a decrease in volatility and the greater the chances of exiting a trade. Note that these conditions are not trading signals since bands do not indicate when the change takes place or in which direction the price could move.
3. ‘W bottoms’ (double bottom)
W bottoms are suitable for setting up long positions. W bottoms require traders to enter when there is a display of strength in the asset. This analysis describes a trend change and momentum reversal from the prior leading price action. W bottoms describe the drop of an asset, a rebound, another drop at a similar level as the original drop, and another rebound, hence ‘W bottoms.’
Technical analysts believe the advance of the first bottom should be a drop of 10 to 20% and the second bottom form within 3 to 4% points of the previous low. Consequently, the volume of the ensuing performance should increase.
For ‘W bottoms’ to produce excellent results, traders are advised to use them for a longer duration, preferably a three-month duration.
4.‘M tops’ (double tops)
Traders use M tops to set up short positions. This strategy requires more confirmation than the double bottom and is suitable to enter when it displays weakness. The M pattern is formed from two consecutive rounding tops. Rounding tops often indicate a bearish reversal since they often occur after an extended bullish period.
Double tops frequently lead to a bearish reversal in which traders profit from selling crypto assets on a downtrend.
Limitations of Bollinger bands
Since Bollinger bands are computed from a single moving average, they consider older price data the same as the most recent, meaning outdated data may dilute new information.
According to its creator John Bollinger, traders should use Bollinger bands and two or three other non-correlated indicators that provide more direct signals. Some of John’s favorite techniques are moving average divergence/coverage (MACD), on-balance volume, and relative strength index (RSI).
Bollinger bands are excellent tools for learning how market volatility fluctuates. Although they offer traders great trading opportunities, it’s important to note that their interpretation varies depending on the current volatility regime. Bollinger bands should never be used entirely as an overbought/oversold oscillator.
Cryptocurrency traders should not rely exclusively on a single indicator but rather combine Bollinger Bands with other indicators to identify entry and exit points. The good thing about Bollinger bands is that they offer traders the option of combining them with other indicators to form buy or sell decisions.
Cryptocurrency traders should do more extensive research before venturing into the crypto trading world to avoid incurring losses. With the above insight, anyone can venture into the crypto-investment space and begin their crypto trading journey.