What are Bollinger Bands?

Bollinger Bands (BB) were created in the early 1980s by financial analyst and trader John Bollinger. Bollinger Bands are widely used as a tool for technical analysis (TA), which is basically an oscillator gauge that indicates whether the market has high or low volatility, as well as whether it is overbought or oversold.

The main idea of ​​the BB indicator is to show how prices are distributed according to the average cost. More specifically, the indicator consists of an upper band, a lower band, and a moving average (also called a middle band). Both sidebands react to market price activity, widening when volatility is high (moving away from the midline) and narrowing when volatility is low (moving toward the midline).

The standard Bollinger Bands formula sets the middle line as a 20-day simple moving average (SMA), while the upper and lower bands are calculated based on market volatility relative to the SMA (called the standard deviation). Standard settings for the Bollinger Band indicator will look like this:

  • Middle Band: 20-day simple moving average (SMA);

  • Top band: 20-day SMA + (20-day standard deviation x2);

  • Lower band: 20-day SMA - (20-day standard deviation x2).

The standard BB setting confirms the 20-day period, and sets the upper and lower bands to two standard deviations (x2) from the center line. This is done to ensure that at least 85% of the price data moves between these two bands, but the settings can be adjusted to suit different needs and trading strategies.


How to use Bollinger Bands in trading?

Although Bollinger Bands are widely used in traditional financial markets, they can also be used for cryptocurrency trading setups. Naturally, there are different ways to use and interpret the BB indicator, but using Bollinger Bands as a stand-alone tool should be avoided and should not be considered an indicator of buying/selling opportunities. Instead, BB should be used in conjunction with other technical analysis techniques.

With this in mind, let's imagine how the data from the indicators represented by Bollinger Bands could potentially be interpreted.

If the price moves beyond the moving average and exceeds the upper Bollinger band, it can probably be assumed that the market is overstressed (overbought). Or, if price touches the upper band multiple times, it could indicate a significant resistance level.

In contrast, if the price of a particular asset falls significantly and exceeds or touches the low band several times, the likelihood is that the market is either oversold or has found a strong support level.

Therefore, traders can use BB (along with other TA indicators) to determine their selling or buying targets. Or also get an overview of previous points where the market presented overbought and oversold conditions.

Additionally, the expansion and contraction of Bollinger Bands can be useful when trying to predict moments of high or low volatility. Groups can either move away from the midline as the price of the asset becomes more volatile (expansion) or move towards it as the price becomes less volatile (contraction).

Thus, Bollinger Bands are better suited for short-term trading as a way to analyze market volatility and try to predict upcoming movements. Some traders speculate that when the bands are redistributed, the current market trend may be close to a period of consolidation or trend reversal. Alternatively, when the bands become too narrow, traders tend to assume that the market is about to make an explosive move.

When the market price moves sideways, the BB tends to narrow the simple moving average. Typically (but not always), low volatility and severe deviations precede large and explosive moves, which typically occur once volatility is backed up.


Bollinger Bands vs Keltner Channels

Unlike Bollinger Bands, which are based on SMAs and standard deviations, the modern version of Keltner Bands (KC) uses the Average True Range (ATR) to set the channel width around a 20-day exponential moving average (EMA). Hence, the formula The Keltner channel will look like this:

  • Middle line: 20-day exponential moving average (EMA)

  • Channel Upper Line: 20-day EMA + (10-day ATR x2)

  • Bottom Band: 20-day EMA - (10-day ATR x2)

Generally, the Keltner Channel Indicator tends to be tighter than the Bollinger Bands. Therefore, it can be better than BB in identifying trend changes and overbought/oversold markets in a clearer and more obvious manner. Additionally, the KC indicator usually provides an overbought/oversold signal earlier than the BB.

On the other hand, Bollinger Bands tend to be a better representation of market volatility since expansion and contraction moves are much broader and clearer compared to KC. Moreover, by using standard deviations, the BB indicator is less susceptible to false signals because its width is larger and therefore harder to cross.

Between BB and KC Bollinger Bands are more popular. However, both indicators are good, especially for short-term trading setups, and can also be used together to provide more reliable signals.