What are the Bollinger Bands indicator?

The Bollinger Bands indicator (BB) was created by financial analyst and trader John Bollinger in the early 1980s. The Bollinger Bands indicator is widely used as a (financial analysis) tool in the field of technical analysis (TA). Basically, it is an oscillator that indicates high and low fluctuations in the market, as well as overbought or oversold conditions.

The main principle of the Bollinger Bands indicator is to emphasize how prices fluctuate around a mean. More specifically, the indicator consists of an upper band, a lower band, and an intermediate moving average (also called the middle band). The two lateral bands react to market price action, expanding (moving away from the middle band) when volatility is high and contracting (moving toward the middle band) when volatility is low.

The standard Bollinger Bands formula sets the middle band to the 20-day simple moving average (SMA), while the upper and lower bands are calculated based on market volatility (called standard deviation) relative to the SMA. The standard configuration of the Bollinger Bands indicator is shown below:

  • Middle line = 20-day moving average (SMA)

  • Upper Line = 20-day SMA + (20-day standard deviation x 2)

  • Lower line = 20-day SMA - (20-day standard deviation x 2)

The standard Bollinger Bands use a 20-day period and set the upper and lower bands two standard deviations (x2) away from the middle line. This is done to ensure that at least 85% of the price data will fluctuate between these two bands, but the setting size can also be adjusted according to different needs and trading strategies.


How to use Bollinger Bands indicator in trading?

Although Bollinger Bands are widely used in traditional financial markets, they can also be used in cryptocurrency trading systems. There are various ways to use and analyze Bollinger Bands, but one should not use Bollinger Bands as a standalone tool or as an indicator to indicate buy/sell opportunities. Instead, Bollinger Bands should be used in conjunction with other technical analysis indicators.

With this in mind, let’s think about how one might interpret the data provided by the Bollinger Bands indicator.

If the price is above the moving average and above the upper Bollinger Bands, it is probably safe to assume that the market is overextended (overbought) at this time. On the other hand, if the price touches the upper band multiple times, it may indicate a significant level of stress.

Conversely, if the price of certain assets drops significantly and exceeds or touches the lower band multiple times, the market may be oversold or have reached a strong support level.

Therefore, traders can use Bollinger Bands (and other TA indicators) to set their sell or buy targets, and likewise, they can also get an overall idea of ​​overbought and oversold conditions in the market.

Additionally, the expansion and contraction of the Bollinger Bands indicator can be useful when trying to predict moments of high and low price swings. The bands will move away from the middle line (expand) as asset price volatility becomes more intense, or move toward the middle line (contract) as price volatility becomes less intense.

Therefore, the Bollinger Bands indicator is more suitable for short-term trading as a tool to analyze market volatility and try to predict upcoming trends. Some traders believe that when the bands are overextended, the current market may be approaching a consolidation period or about to reach a trend reversal. Similarly, when the bands are too narrow, traders believe that the market will undergo a huge move.

When the market moves sideways, the Bollinger Bands tend to narrow towards the middle simple moving average. Usually (but not always), low volatility and small deviation levels precede large explosive movements, which will occur once volatility picks up.


Bollinger Bands vs Keltner Channels

Unlike Bollinger Bands, which are based on SMA and standard deviation, the modern version of the Keltner Channel (KC) indicator uses the Average Trend Representation (ATR) to set the channel width above and below the 20-day exponential moving average (EMA). Therefore, the formula for the Keltner Channel is roughly as follows:

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

  • Upper Line = 20-day EMA + (10-day ATR x 2)

  • Lower line = 20-day EMA - (10-day ATR x 2)

Typically, Keltner Channels show tighter bands than Bollinger Bands. Therefore, it may be better suited to indicate trend reversals and overbought/oversold market conditions in a clearer and more obvious way than Bollinger Bands. In addition, the Keltner Channel indicator will usually provide earlier overbought/oversold signals than Bollinger Bands.

On the other hand, Bollinger Bands are a better representation of market volatility because they expand and contract more sharply and more clearly than Keltner Bands. Also, by using standard deviation, Bollinger Bands are less likely to provide false signals because they are wider and therefore harder to cross.

Bollinger Bands are more popular than Keltner Channels. However, both indicators are good - especially for short-term trade setups - and both can also be used in conjunction to provide more reliable (market) signals.