How to Use Bollinger Bands for Crypto Trading?

The simple moving average and the upper and lower bands of the standard deviation of the average trend lines make up this measure. 

Bollinger bands can be used to determine whether a cryptocurrency is oversold or overbought, as well as the likelihood of asset volatility. Bollinger bands are sometimes known as lagging indicators because they only infer information after a change has occurred.

Bollinger bands can be used by traders to confirm whether or not a long-term trend has moved. In this post, we'll show you how to use Bollinger Bands for crypto trading to help you understand one of the most reliable indicators ever produced.

Three Lines in Bollinger Bands

Bollinger bands have three lines: upper, lower, and middle. The middle band is a moving average, and its settings are set by the trader. The upper and lower bands are located on either side of the moving average band. The trader chooses the number of standard deviations for the volatility indicator.

The number of standard deviations determines the distance between the middle band and the upper and lower bands. The position of these bands reflects the trend's strength as well as probable high and low price levels in the near future.

[caption id="attachment_226802" align="aligncenter" width="652"] BTC/USDT daily chart Source: TradingView[/caption]

Three Rules of Bollinger Bands

There are three guidelines/rules for interpreting what the Bollinger bands are telling you. But keep in mind that you should always double-check your assumptions with the crypto token's price! Learning how to use Bollinger Bands is a terrific way to improve your cryptocurrency and/or stock trading strategies.

Rule 1: The tranquillity before the storm

The first point to remember about the Bollinger bands is that they are constructed differently. You should expect a sharp price movement in either way as the bands narrow. This occurs because the market remains tranquil until investors purchase or sell a cryptocurrency. 

Then comes the storm, as prices react to investor activity. Price volatility rises as a result, and the bands begin to diverge.

[caption id="attachment_226805" align="aligncenter" width="1376"] BNB/USDT daily chart. Source: TradingView[/caption]

The volatility spiked after nearly two months of low volatility between mid-September and mid-November 2020, and the BNB/USDT pair gave a fantastic trading opportunity, as indicated in the chart above.

Rule2: If the price exceeds a band, the trend is predicted to continue

When the price of a crypto asset trades near or at the bands, it suggests that the market is moving in the right direction. As more traders place buy orders, the price will follow the trend. If the price crosses a band numerous times, however, it indicates trend weariness, in which prices make a short-term decline before continuing the trend.

[caption id="attachment_226806" align="aligncenter" width="1376"] LTC/USDT daily chart. Source: TradingView[/caption]

The price of Litecoin (LTC) began to rise in mid-February 2019 when the middle band turned up, and the price traded between the middle and higher bands, as shown in the above chart. Traders may then attempt to purchase the bounce off the middle band, in this case.

Rule3: Expect a trend reversal when the price changes its trend pattern after crossing a band

Cryptocurrency's price began to create a reversal pattern after reaching its all-time high. First, the price fell below the previous low, triggering an upside pullback and a lower high than the prior high. Finally, the price broke through the orange support line, confirming the anticipation of a downturn.

However, prices crossing above the upper band indicate that the market is overbought, implying that a trend reversal is more likely.

Final Thoughts

The bands widen as the market becomes more volatile, while they close as the market becomes more stable. This tool can be used to forecast market trends and determine whether an asset is oversold or overbought; however, it is recommended that you do not base your decision solely on this indicator and consider external factors that significantly impact the cryptocurrency market.

Also, a drawback of Bollinger bands is that not all traders will benefit from the default settings. Therefore, traders must identify settings that enable them to define trading guidelines for individual tokens.