What is Bollinger Band?

The Bollinger Band is a mechanical examination device composed of chart patterns. It displays two standard deviations apart from a basic moving average of a security's price, but which may be changed to the user's needs. The tool is named after its inventor John Bollinger.

A Bollinger Band is a visual cue used to estimate the unpredictability of a plotted asset. Due to the extreme variability of the asset class, the most often utilized trading method, the breakout trade, is particularly applicable to cryptocurrencies.

By looking at the BTC/USD daily charts traded at Coinbase, you would see that Bollinger Bands are also applied there. To be precise, a Bollinger Band has three lines: upper and lower bands, and a simple moving average.

The charts that use Bollinger Bands illustrate that when the price is nearer to the upper band, the market is more overbought, and when it is closer to the lower band, the market is more oversold, as traders assume.

Important to note though is that John Bollinger has established 22 rules that are needed to be followed when using the bands as a trading system.

The Bollinger Band formula:

​​Middle Band = MA[Source Price, n]

Upper Band = MA[Source Price, n] + (m * n period standard deviation)

Lower Band = MA[Source Price, n] - (m * n period standard deviation)

Where source price can be upper (BOLU), lower (BOLD), etc. (chosen by the user)

n = number of days smoothing period (chosen by the user)

m = number of standard deviations (chosen by the user)

Traders can develop a few methods by using Bollinger Bands:

Breakout Trades

Traders can use Bollinger Bands to trade breakouts by executing the trade in the direction that the price breaches the band. However, if it happens that the price breaches the top band, traders need to enter a long position. If the price breaches the lower band, traders need to enter a short position.

About 90% of price action occurs between the two bands, and any breakout that takes place above or below the bands is a big event.

Because cryptocurrencies are very unpredictable and likely to trend for longer durations, using Bollinger Bands for breakout trading on Bitcoin or other cryptocurrencies is preferred over mean reversion transactions. Besides, it’s essential to do some research beforehand.

To apply the method traders can begin by waiting for the price to hit the bottom band and then taking a long position when it happens. Then they set a trailing stop with the 20 MA as the stop price. Each moment the MA changes, they move the stop. Finally, they can only abandon the trade when the price re-approaches the 20 MA.

Mean Reversion

Traders can also employ Bollinger Bands by waiting for the market to reach the lower or higher bands before acting. When the price trades near the bands, the chance of the market becoming overbought or oversold increases. 

As a result, the mean reversion trader will enter a short position when the price reaches the higher band, and a long one when the price hits the lower band.

However, the method cannot be as fitting with Bitcoin or other similar cryptocurrency markets.

Bollinger Band is not a networkable trading system. Moreover, this is an indicator that it is created to offer traders with data on price swings. The creator John Bollinger suggests combining it with two or three non-correlated markers, based on distinct sorts of data.