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 technical analysis instrument (AT or TA in English), concretely it is a tool for measuring oscillations which indicates whether the market has high or low volatility and whether the trends are overbought or oversold.

The main idea of ​​the BB indicator is to highlight how prices are distributed around an average value. More specifically, the indicator is composed of an upper band, a lower band and a moving average line (also called a middle band). The two sidebands respond to market price action, 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 defines the middle line as a 20-day simple moving average (SMA), while the upper and lower bands are calculated based on relative market volatility. to the SMA (called standard deviation). The standard settings for the Bollinger Bands indicator are as follows:

  • Midline: 20-day simple moving average (SMA)

  • Upper Band: 20-day SMA + (20-day standard deviation x2)

  • Lower Band: 20-day SMA – (20-day standard deviation x2)

The standard BB parameter therefore takes into account a 20-day period and sets the upper and lower bands two standard deviations (multiplied by 2) from the midline. This ensures that at least 85% of price data will move between these two bands, but these settings can also be adjusted according to different needs and trading strategies.


How to use Bollinger Bands in trading?

Although Bollinger Bands are widely used in traditional financial markets, they can be interpreted very well to trade cryptocurrencies. Obviously, there are different ways to use and interpret the BB indicator, but one should avoid using Bollinger Bands as an independent instrument and not consider it as an indicator of buying opportunities. or sale. BB should instead be used in combination with other technical analysis indicators.

With this in mind, let's see how one can interpret the data provided by the Bollinger Bands indicator.

If the price is above the moving average and exceeds the upper Bollinger band, one can probably assume that the price is excessively high (overbought condition). Or, if the price touches the upper band several times, this may indicate a significant resistance level.

On the other hand, if the price of some asset falls significantly and exceeds or touches the lower band several times, there is a good chance that the market is oversold or that a strong support level has just been reached .

Therefore, traders can use BB (among other Technical Analysis indicators) in order to set their sell or buy targets. But also to gain insight into previous points where the market exhibited overbought and oversold conditions.

Additionally, the expansion and contraction of Bollinger bands can be used to attempt to predict times of high or low volatility. Bands can move away from the midline when the asset's price becomes more volatile (expansion) or toward it when the price becomes less volatile (contraction).

To recap, Bollinger bands are therefore rather suited to short-term trading to analyze market volatility and attempt to predict future movements. Some traders therefore assume that when the bands are very far apart, the current market trend may be close to a period of consolidation or a trend reversal. Alternatively, when the bands become too tight, traders tend to think that the market is preparing to make an explosive move.

When the market price moves sideways, the BBs tend to move closer to the simple moving average that is in the middle. Typically (but not always), low volatility and tight spreads precede large, explosive moves, which tend to occur as soon as volatility increases again.


Bollinger Bands compared to Keltner Bands

Unlike Bollinger Bands, which rely on the MMS (simple moving average or SMA in English) and standard deviations, the modern version of the Keltner Bands (KC or Keltner Channels) indicator uses the Average True Range (ATR or real average range in French) to define the width of the channel around a 20-day exponential moving average (most often called EMA for exponential moving average). Therefore, the Keltner Bands formula is established as follows:

  • Midline: 20-day exponential moving average (EMA)

  • Upper channel line: 20-day EMA + (10-day ATR x2)

  • Lower band: 20-day EMA – (10-day ATR x2)

Generally, the Keltner Bands indicator tends to be narrower than the Bollinger Bands. Also, it appears better suited than BB to detect trend reversals and overbought/oversold market conditions in a clearer and more obvious manner. Finally, the KC indicator usually provides the overbought/oversold signal earlier than BB.

In contrast, Bollinger bands tend to better reflect market volatility because the expansion and contraction movements are much broader and explicit compared to KC. Additionally, by using standard deviations, the BB indicator is less likely to provide false signals, because its width is larger and, therefore, more difficult to exceed.

If we compare BB and KC, Bollinger Bands are the most popular. However, both indicators are interesting - especially for short-term trading setups - and can also be used in combination to obtain more reliable signals.