Bollinger band line is a technical indicator that helps investors determine the right time to buy or sell. This helps optimize positions effectively. Based on price fluctuations, this indicator provides an objective view of the market. Let’s explore Crypto Trading through the article below to better understand this special tool. We will answer all questions of new investors about Bollinger Bands in the most detailed way!
Introduction What is Bollinger Band Line?
John Bollinger is one of the world’s leading financial analysts. He is known as the father of the Bollinger Band indicator. He developed this indicator in 1983, and since then, it has remained one of the most popular tools. So how to understand the Bollinger Band indicator? What is the structure and calculation method of Bollinger Band? Let’s explore the details in the following sections.
Definition of Bollinger band line
Bollinger Bands is an analytical tool that combines the Moving Average (MA) and the standard deviation. This indicator consists of a moving average in the middle, along with two upper and lower bands.
Price volatility determines the distance between the MA and the Bollinger Band. When the price of a security is highly volatile, the Bollinger bands will widen, and when the price is less volatile, the bands will narrow.
Bollinger Bands Structure
Bollinger Bands is a useful tool for measuring price volatility. It is used to identify trends and find appropriate entry points for traders. This indicator consists of 3 main components as follows:
- Simple Moving Average (SMA): This is an average of the closing prices of an asset over a specified number of periods. Typically, an SMA is calculated by taking the sum of the closing prices over that period and dividing it by the number of periods.
- Upper Bollinger band line: This is a line above the SMA, usually two standard deviations away from the SMA. This line represents a high potential price level.
- Lower Bollinger band line: Similarly, this is a line below the SMA, usually two standard deviations away from the SMA. This line represents a potential low price.
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What is the formula for calculating Bollinger Bands?
The formula for calculating Bollinger Bands is very simple. As mentioned, Bollinger Bands consists of 3 bands, and the specific calculation is as follows:
Middle band: This is the 20-day moving average (SMA20), which is calculated by averaging the closing prices.
Upper band: SMA20-day + (2 x 20-day Standard Deviation)
The lower band of the Bollinger Band is the result of subtracting twice the 20-day standard deviation from the 20-day SMA.
Analyzing the meaning of Bollinger band line
The Bollinger Bands indicator carries two important meanings that investors need to understand: the narrowing (tightening) of the Bollinger Bands and the breakout (Breakout).
Bollinger band line tightens (narrows)
The narrowing of Bollinger Bands is an important concept. When the Bollinger Bands contract, the distance between the upper and lower bands and the SMA line narrows. This phenomenon indicates stability in the volatility of the asset, with minimal volatility. This provides a signal for the return of stronger volatility in the future. It helps create ideal conditions for investors to enter the market and take advantage of profit opportunities.
Conversely, expansion is the opposite phenomenon. When Bollinger bands expand, volatility increases, and exit rates also increase. However, this does not lead to any prediction of future price direction.
Bollinger Bands breakout
Bollinger Bands breakout should not be considered a definitive trading signal. Although many investors often make this mistake. This is because the breakout does not provide a clear indication of the direction the price is about to move. Instead, it only shows that the price may move to a certain area and is unlikely to break out of it. Therefore, Bollinger Bands provides investors with an important hint of the price zone that may become a turning point. This trick shows its power when assessing short-term, medium-term, and long-term trends. It aims to provide reliable analysis results in all time frames.
Learn how to use Bollinger Bands most accurately
In the investment field, developing a trading strategy is extremely important and indispensable. Below, we will share with investors the best settings for Bollinger bands.
A strategy combining RSI and Bollinger Bands
The RSI indicator stands for Relative Strength Index, which means “relative strength index”. Using RSI is quite simple: when RSI exceeds 70 (overbought), and crosses down, this is the right time to sell. Conversely, when RSI is below 30 (oversold), and crosses up, this is the time to buy.
However, when you combine RSI with Bollinger Bands, the usage becomes more complicated. The key is to find RSI divergence. There are two types of divergence: bearish divergence and bullish divergence, which indicate an impending reversal. When combining RSI with Bollinger Bands, you need to consider:
- When the price goes away from Bollinger Bands, it tends to return to the middle band SMA20.
- RSI divergence is bearish when the market makes higher highs but RSI is falling.
Based on these two factors, the transaction is executed as follows:
- If the price is up and at the upper Bollinger Bands, look for a bearish RSI divergence.
- Conversely, if the price is heading down and at the lower Bollinger Bands, look for a bullish RSI divergence.
- Combined with the signals from RSI and Bollinger Bands, we have a potential reversal trade.
Combining Bollinger band line with reversal patterns
To increase efficiency, Bollinger Bands can be combined with reversal patterns. Reversal identification is simple and often involves double-top and double-bottom patterns.
How to identify Bollinger Band reversal pattern on chart:
- Add Bollinger Bands indicator (20 periods, 2 standard deviations) to the chart (usually daily or hourly time frame).
- Identify previous trend lines using technical indicators or price action.
- Distinguish between two tops or two bottoms, depending on the previous trend.
- Find the first top or bottom that breaks the respective Bollinger Band.
- Wait for the appearance of a second top or bottom without breaking the Bollinger Band.
- Open an order at this point or apply the traditional double top/double bottom method and use the bottleneck line as a reference point.
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Bollinger Squeeze
The Bollinger Bands indicator is characterized by the upper and lower bands almost covering the entire price line. This creates the “Bottleneck” or Bollinger Band Squeeze trading method, which is the classic method with this indicator.
The market fluctuates between strong and gentle changes. When the fluctuations are small for a long time, it is a sign of strong fluctuations to come, When a bottleneck appears, it is a signal that the area will have strong fluctuations, which is an ideal time to trade.
When this signal appears, wait for a breakout from the narrow accumulation zone created by the price. If the breakout is up, place a buy order. Conversely, if the breakout is down, place a sell order.
Bollinger Bands Strategy Buy Low and Sell High
By using the Bollinger band line, traders can build a “Buy Low, Sell High” strategy. This strategy is based on using the upper and lower bands of the Bollinger Band as support and resistance levels. When the price touches the upper band, traders sell; and when the price touches the lower band, traders buy.
In a range market, this strategy is simple but relatively effective. However, in a strong uptrend or downtrend, this strategy can be risky. For new investors, this strategy should be used as a way to better understand Bollinger Bands and its basic uses. To apply it in trading, good screening skills are needed to recognize real signals and eliminate noise signals in the market.
Limitations of Bollinger band line that traders need to know
Bollinger Bands are an easy strategy to use, especially for new investors. However, Bollinger Bands also have limitations.
First, when used alone, Bollinger Bands have limitations. John Bollinger recommends combining Bollinger Bands with 2 or 3 other indicators instead of using them alone. The most popular combination is Bollinger Bands and RSI.
Second, Bollinger Bands cannot predict price breakouts. They only indicate the current market volatility trend, not the future.
Third, it is not possible to determine the overbought and oversold times. Stop-loss orders should be used to deal with price deviation situations.
Fourth, Bollinger Bands cannot indicate the strength of the current trend. This can lead to risky trading when the market develops a strong trend.
Fifth, in case the market fluctuates too strongly or quickly, the predictions of Bollinger Band will not be accurate.
Conclude
As presented in the article, Crypto Trading has fully synthesized knowledge about the Bollinger band line. However, to maximize its effectiveness, combining it with specific strategies and directions is very important. The article provides detailed information about Bollinger Band as well as related concepts. To understand more deeply about other aspects of the investment field, continue to follow our next articles.
FAQs
What is Bollinger’s band line?
The Bollinger band line is a technical indicator developed by John Bollinger in 1983. It consists of three bands: a moving average and two side bands.
How do Bollinger Bands quantify market volatility?
Bollinger Bands measures volatility by tracking the standard deviation of price from a moving average. When volatility is high, the bands widen and when volatility is low, the bands narrow.
Which markets can Bollinger Bands be applied to?
Bollinger Bands can be applied to all financial markets. Including stock, forex and cryptocurrency markets.
