Bollinger Bands

Brief Overview

There are many statistical charting tool which traders employ to partake in the financial markets. These tools are used to get the volatility of a financial asset.

Bollinger bands is one of them and it was created and developed by John Bollinger. Traders use Bollinger bands as a mechanism for making informed trading decisions, or a as a means to control automated trading systems. Traders can also employ the Bollinger band trading indicator in conjunction with other technical analysis tool.

What is Bollinger Bands?

It is a technical indicator or tool which was created to help traders determine the financial market's Volatility. It also serves as an indicator that can help traders to determine the markets Overbought and Oversold situations.

It is a technical indicator that has an Upper Band, a Lower Band, and a line in the middle which is usually a Moving Average.

Naturally, Bollinger bands helps to provide a good definition of high and low price movements in the crypto market. So when prices are located in the upper layer of the band, then it can be said that prices are high, conversely, when prices are found in the lower layer of the band, it can be said that prices are low.

How it works

The Bollinger Band indicator has an Upper Band/Limit and a Lower Band/Limit and a middle line in between them, known as the Moving Average. These Bands/Limits acts as dynamic support or resistance price levels because the market has been confined to those Bands/Limits as dictated by the parameters of the Bollinger Band indicator.

There are mainly two periods that are found out when using the Bollinger Band indicator. They are periods of

• Low Volatility and,
• High Volatility.

The way the Bollinger band works is that when the crypto asset is experiencing a period of low volatility, the upper band and the lower band becomes tight, that is, contract. So the movement of the market at this period in time is confined to the upper and lower band level.

Then when the Bollinger band indicator experiences periods of high volatility, the upper band and the lower band becomes loose, that is, expands. At such periods, the crypto asset price level breakout from the Bollinger band and move in a certain direction, thereby leading to a major uptrend or major downtrend.

Also with the bands/limits, a trader can use these points as indicators for trend reversals, or support and resistance levels.

Calculation Method

There are three lines in the Bollinger Band.

• Top line - Upper Band/Limit
• Middle line - Moving average
• Low line - Lower Band/Limit

The model used to calculate the moving average follows thus,

Moving Average = Sum of prices over given period of time / Number of period.

As this Moving Average has been calculated, then the Bollinger band can be formed. The Bollinger band uses the volatility/standard deviation of the moving average. So with this, if there is a high volatility of the crypto asset, the Bollinger band would expand and a trend can occur, in the same vein if the volatility is low Bollinger band would contract and there would be low movement of the crypto asset price.

Best Bollinger Set-up

The best set up for the Bollinger band is 20 and 2. This is usually the default parameters in the Bollinger band settings.
20 represents the Length, which is the amount of candlesticks that the indicator uses in it's parameters, as part of the data it needs to bring about an indication. While 2 is the Standard Deviation. This standard deviation is how the upper band and the lower band spread out from the middle line (Moving Average).

Determining a Breakout in Bollinger Bands

What is a Breakout

A breakout in Bollinger bands is when the candle sticks of a crypto asset pair 'breakout' from the upper band or lower band of the Bollinger bands indicator.
This breakout often occurs after the Bollinger bands have contracted/shrunk, that is, the market is experiencing a period of low volatility. After such periods, a break out usually occurs.

And it is during this breakout period that the Bollinger band expand/widens, which shows that the market volatility has increased.

Determining a Breakout

_{Figure1: Determining breakout on the Bollinger Bands Indicator}

This is a Daily timeframe on the chart of TRX/BUSD.

From the Bollinger band plotted on the chart, we can see that a massive breakout had occurred, after periods of low volatility when the Bollinger band indicator contracted/shrunk, before the massive breakout took place.

The yellow arrows shows the breakout at different points. The first yellow arrow shows the first breakout, but the volatility was low as shown by the shrunk Bollinger bands. The price then retracted before finally breaking out massively as shown in the other arrows. At this period in time the Bollinger band expanded, which indicated high volatility.

Using Bollinger Bands on a Trending Market

One of the best ways to see the market trend is through the eyes of the Bollinger bands. With the Bollinger bands it is easier to spot when the market is trending in an upwards direction or a downwards direction.

The Bollinger bands envelops the candlesticks as it moves up and down. This makes it easier to spot an uptrend or a down trend. As the Bollinger bands moves up, it shows that the market is in an uptrend, and likewise as the Bollinger bands moves down, this indicates that a downtrend is going on.

_{Figure2: Trending Markets on Bollinger Bands Indicator}

From the chart above, we can see that the Bollinger band faced up, which meant the market was in an uptrend. Then the Bollinger band also later faced down, this indicated that the market was in a downtrend.

Best Indicator to Use with Bollinger Bands

There are so many indicators to use in conjunction with Bollinger bands, but the best so far is the use of support and resistance levels. This is because there are times the market doesn't move in a particular trend, either up or down, but rather moves sideways, mostly in a range. At such points you can't determine if the market is in an uptrend or in a downtrend. So the best tool to use to get good point on the chart is the support and resistance line. With these lines you can get a good range of where the market price level could be at a given point in time.

_{Figure3: Support & Resistance with Bollinger Bands Indicator}

From the chart above we can see our support and resistance line labeled A & B. A being the support and B being the resistance line.

We can see that after the initial trend, the trend hit the resistance line B, retraced and then hit the support line A, and then the same thing occurred. Within this period when the price of the asset was in a range, there were times the price did not hit the support line A, also there were also times that the price broke through the resistance line B, after which they retracted. Finally at the tail end of the ranging movement period, the price hit the resistance line B then went down and broke past the support line thereby confirming the downtrend.

Best Timeframe to Use Bollinger Bands

The best timeframe to use Bollinger Bands depends exclusively on the kind of trader that is using the Bollinger band indicator, with respect to their trading style and personality.

But i believe the best trading timeframe to use Bollinger band is the Daily timeframe chart. With the daily timeframe, you get a solid perspective of the market movement, because the market doesn't move fast like those in the lower timeframes. So you have the time to analyse the movement of the crypto market prices with the Bollinger bands.

_{Figure4: Daily Timeframe with Bollinger Bands Indicator}

The image above is a daily timeframe chart that the Bollinger band indicator has been plotted upon. It give a clearer view of the market, and how the market is moving at the moment. The blue arrow shows the timeframe of this chart.

Signals from Chart using Bollinger Bands

_{Figure5: Signals form AAVE/BTC chart using Bollinger Bands Indicator}

From the chart of AAVE/BTC above there are a lot of signals that are shown on the chart.

By February, the market was in an upward trend, and this made the Bollinger band to expand at that period in time. After the upward trend, the market retraced back a little bit. The label A shows the time when the market retraced. Then during March and April, the market eventually entered periods of low volatility, this was when the Bollinger band contracted. Within this period of contraction, the price levels formed support and resistance levels which the crypto asset oscillated between before eventually breaking out.
The price of this crypto asset finally brake out in May , we can see the breakout of the candles from the Bollinger bands in B. At this period, the Bollinger band also expanded, which shows that volatility was high.

PS: All images used are from binance.com, except otherwise stated.

Thank you @kouba01 for this wonderful exercise