In the practice of trading in the cryptocurrency market, the Bollinger Bands are commonly used technical indicators to determine the price 'entry and exit timing.' By incorporating the concepts of average and standard deviation, one can identify price breakout points and reversal points in the market. Bollinger Bands can also be used to assess conditions of overbought and oversold in market prices.
1️⃣ Application of the Bollinger Bands indicator
1/ Support and resistance indications: The upper and middle bands of the Bollinger Bands exert pressure on the cryptocurrency price, while the middle and lower bands provide support. When the price breaks out above the upper band, a pullback may occur. Recently, the upper and middle bands of the Bollinger Bands exert pressure on the price, while the middle and lower bands provide support. When the price breaks out above the upper band, a pullback may occur, and when it falls below the lower band, a rebound may occur, indicating overbought and oversold conditions. In cryptocurrency trading, for example, when BTC experiences sharp price fluctuations and touches the upper band of the Bollinger Bands, it often faces pullback pressure due to profit-taking in a short period; conversely, when Bitcoin's price significantly drops near the lower band of the Bollinger Bands, some bottom-fishing funds may enter the market, pushing the price upward.
2/ Trend judgment: Strong cryptocurrencies often operate between the middle and upper bands, while weak cryptocurrencies frequently run below the middle band. When the price line is above the middle band of the Bollinger Bands, it is generally a bull market, suggesting holding positions or buying; when below the middle band, it is mostly a bear market, and buying should be cautious. The upper and lower bands of the Bollinger Bands represent extremely strong and weak conditions, respectively. Taking Ethereum as an example, during its bullish market phase, the price generally maintains between the middle and upper bands of the Bollinger Bands, showing strong upward momentum; whereas in bear market phases, the price often stays below the middle band for a long time, indicating a strong bearish atmosphere in the market.
3/ Signals of band changes: If the upper and lower bands of the Bollinger Bands narrow, there may be a potential breakout. Do not rush into trading. If the cryptocurrency K line breaks upward through the upper band with an increased volume and the channel opens upward, it signals that the price will enter an upward channel and should be bought; if the K line breaks downward through the lower band with the channel opening downward, it indicates that the price will enter a downward channel and should be sold. For emerging popular cryptocurrencies, when the Bollinger Bands narrow during initial low volatility, once there is a volume breakout, it often initiates significant price movements, and investors need to make timely decisions based on the breakout direction.
4/K line breakout situation: If the cryptocurrency K line breaks upwards from below the middle band, it indicates strong price momentum, and buying is advisable. If it breaks upwards from above the middle band to the upper band, it indicates extremely strong price momentum, and a short-term surge may occur, suggesting holding or short-term buying. Certain niche but highly potential cryptocurrencies, propelled by significant positive news, may have K lines strongly breaking above the upper band, resulting in a meteoric rise in price in a short time. If investors can seize this opportunity in time, the returns can be substantial.
5/ Cryptocurrency price trend above the Bollinger Bands: After the K line runs above the Bollinger Bands for a period, if it turns around and breaks down through the upper band, it signals the end of a strong short-term trend, and investors should sell in a timely manner, especially for those cryptocurrencies that have surged significantly in the short term; if it breaks down through the middle band, selling should primarily be the strategy. Taking Polkadot as an example, after a rapid surge, if the K line oscillates at a high position above the Bollinger Bands and then suddenly turns down to break through the critical track, it is often a signal of trend reversal. If investors do not exit in time, profits will quickly shrink.
The formula for Bollinger Bands is illustrated here using the most common parameters, and the formulas are as follows:
Middle band: 20 MA
Upper band: 20 MA + 2 standard deviations
Lower band: 20 MA - 2 standard deviations
Bandwidth (channel space): (upper band - lower band) / middle band
2️⃣ Ten basic patterns of Bollinger Bands
1/ Contraction of the Bollinger Bands
When the upper and lower bands of the Bollinger Bands are close, market volatility decreases, indicating that significant price fluctuations are imminent. In the red box on the chart, price fluctuations often accompany a contraction of the bands, which investors should pay attention to.
2/ Expansion of Bollinger Bands
The upper and lower bands quickly diverge, and market volatility increases dramatically. Recently, the upper and lower bands have rapidly separated, with significant price fluctuations. The chart shows that after expansion, there are substantial price movements, and investors need to make decisive decisions and manage risks carefully.
3/ Touching or breaking the upper band
When the candlestick touches or surpasses the upper band, the market may be overheated and overbought, but the price may not necessarily fall. High price levels signal strong warnings, while low price levels may have upward breakout potential; investors need to combine this with area judgment.
4/ Touching or breaking the lower band
When the candlestick touches or breaks the lower band, the market is overly cold and oversold, which does not mean the price will rise immediately. Investors should observe the area and combine indicators to judge the trend and make cautious decisions.
5/W-shaped bottom
A double bottom near the lower band, with the second bottom slightly higher, is a bullish pattern indicating a potential rise. Buying when the price crosses the middle band can reduce risk, as shown in the chart with examples in the black box for investors to seize the opportunity.
6/M-shaped top
The double top at the upper band, with the second top lower than the first, is a bearish pattern, indicating a potentially large decline. Investors should be cautious when buying in such scenarios and may consider short selling, as demonstrated in the chart.
7/ Corridor running
The candlestick runs along the upper or lower band of the Bollinger Bands, indicating a strong trend, but a reversal may occur at any time, as marked by the black box. Investors should not be careless and should set appropriate stop-loss and take-profit levels.
8/ Bollinger reversal
The candlestick repeatedly touches the bands without a trend, moving sideways within the channel. The market is range-bound, and investors can engage in swing trading, buying low and selling high, adjusting strategies once the market shows a direction, as exemplified in the chart.
9/ False breakout of Bollinger Bands
When the candlestick breaks above the upper band and quickly retreats, it creates a misleading appearance for retail investors, not a true trend. Traders should analyze multiple indicators to distinguish between 'traps' and 'opportunities.'
10/ Contraction breakout
The contraction of the Bollinger Bands and market consolidation is a prelude to significant price movements. The black box in the chart indicates consolidation, while the red box demonstrates the breakout, expansion, and price increase, and investors need to seize the timing for entry.
3️⃣ How to use Bollinger Bands to capture reversal and trend initiation opportunities
Bollinger Bands signal trend changes through contraction; so when the trend starts, if the Bollinger Bands are already in a contracted state, how can one track the emergence of the trend? This requires using the opening function of the Bollinger Bands in conjunction with the relationship between the candlestick and the Bollinger Bands for dual-directional judgment. Compared to judging the end and change of a trend, identifying the initiation of a trend is somewhat more complex.
Let’s first learn the first condition: the opening of the Bollinger Bands
The current market situation is in a state of fluctuation. Regardless of whether the market subsequently develops into a bull market or a bear market, once the current fluctuation ends, the Bollinger Bands will inevitably open up. The characteristics of the opening of the Bollinger Bands are very evident: the upper band opens upward, the lower band opens downward, and they spread apart. This obvious characteristic is consistent in both upward and downward movements.
When the Bollinger Bands display an opening, we already know that a unidirectional trend is likely to arrive. So, how do we judge the direction of the trend? This requires using the second skill, the relationship between the Bollinger Bands and the candlesticks. This again divides into two points.
Firstly, when the bands open, if the candlestick is touching the upper band and moving upwards, it indicates the arrival of an upward trend; if the candlestick is touching the lower band and moving downwards, it signals the emergence of a downward trend.
Secondly, if the closing price of the candlestick is above the upper band and it is a bullish candlestick, it indicates an ongoing upward trend; if the candlestick is bearish and the closing price is below the lower band, it indicates an ongoing downward trend.
In Figure 14, it can be clearly seen that after a downtrend occurs, the candlestick closes below the lower band of the Bollinger Bands and continues to drop closely along the lower band.
Therefore, using the Bollinger Bands to timely identify the initiation point of a trend involves two factors: firstly, the Bollinger Bands must be opening; secondly, if there is an upward trend, the candlestick's closing price will break through the upper band; if there is a downward trend, the closing price will break through the lower band.
Having confirmed the initiation of a trend through these two points, traders can immediately enter the market in the direction of the price. If it is a downtrend, the stop-loss should be set above the middle band; if it is an uptrend, the stop-loss should be set below the middle band.
If a downtrend occurs, and the price subsequently runs closely along the lower band of the Bollinger Bands (refer to the diagram), traders can hold onto short positions until the Bollinger Bands change from an opening state to a closing state again. Of course, there is also a more timely exit method: when the price breaks above the middle band of the Bollinger Bands, close the short position immediately. Following this exit method, we see in the chart that it almost captures an entire bullish trend, as breaking through the middle band also represents a trend reversal.
Although Bollinger Bands are useful, their effectiveness may vary due to individual subjective perceptions, like a double-edged sword. Therefore, one should never overly rely on a single indicator. It is better to refer to multiple indicators for a combination to avoid getting misled by the indicators. However, as the old saying goes, technical indicators are ultimately 'probabilities.' There is no absolute certainty, only whether you understand the indicators, whether you can find your own application method, and whether you can persistently use them. Only with long-term use can one appreciate the benefits that indicators bring.
Let's encourage each other!