Is Bitcoin Overbought or Oversold? Use Bollinger Band to find out!

Trading is not exactly a science or an art. It’s a combination of both. Many indicators are provided for free and any given signal is the best. However, none of these are perfect or designed for individual use.

One of the most popular indicators that are widely used by many traders is the Bollinger Band, an indicator that can be used to identify spikes, lows, and short selling opportunities when the rally is exhausted and bought during pullbacks.

Let’s learn three simple methods to use this indicator in trading.

What is Bollinger Band?

John Bollinger developed and copyrighted the Bollinger Bands indicator in the 1980s. The indicator consists of the middle band, a simple moving average (SMA) with the default value set at 20 periods and two above the middle band.

BTC / USDT daily chart | Source: TradingView

Its most basic use is to determine whether a price is high or low on a relative basis. If the price is above the upper band, the asset is considered overbought. However, if the price falls below the lower band, the coin is considered oversold.

However, many traders mistakenly assume that the asset price will fall when it hits the upper band or that a rally will begin when the price hits the lower band.

This usually only happens when the price is stuck in a range. As with any other indicator, assumptions in a trending market can easily lead to large losses, so finding a consolidation from multiple indicators remains a good method.

Let’s look at some of the ways traders use the Bollinger Bands indicator.

Bollinger Bands can detect volatility distortions

According to John Bollinger, assets often switch between periods of low volatility and high volatility. Therefore, after periods of low volatility, traders can expect increased volatility, which can lead to trend-following movements.

XRP / USDT daily chart | Source: TradingView

The above chart shows how much the XRP volatility dropped from mid-September to mid-November 2020, marked by the ellipse on the chart. After about two months of low volatility, the volatility has increased and the XRP / USDT pair offers a great trading opportunity.

BNB / USDT daily chart | Source: TradingView

In the example above, Binance Coin (BNB) was in a downtrend and volatility worsened from mid-September to mid-November 2018, indicated by an ellipse on the chart. Here volatility expanded on the downside and the BNB / USDT pair continued its downtrend.

Tight volatility does not provide a signal to determine the direction of the next breakout. Sometimes market makers push the price above the upper band or below the lower band to attract new traders. Therefore, traders should avoid determining direction in advance and waiting for the price to break out of the range before taking a position.

ETC / USDT daily chart | Source: TradingView

The graph above shows how aggressive bulls and bears got stuck. On October 22, 2020, the bulls pushed the price above the upper band but failed to break the resistance at $ 5.77. Then on November 3, 2020, the price fell below the lower band but failed to break the USD 4.58 support.

Ethereum Classic (ETC) broke above $ 5.77 on November 18, 2020, but it wasn’t a perfect trade as the price didn’t trigger a strong uptrend. The price retested the breakout level on December 22nd.

The price plummeted below this level on December 23, 2020, but this was just a false breakout. The market makers hunted the buyers’ stop loss and caught the aggressive bears through this move.

The price bounced back quickly on December 24th, 2020 and the ETC / USDT pair soon started a strong upward move.

Therefore, rather than relying solely on signals from the Bollinger Bands indicator, traders should also seek confirmation from other indicators or use support and resistance levels.

Bollinger Bands can signal when to buy on a pullback

A pullback in an uptrend is often a buying opportunity as the primary trend often tends to reassert itself. If the middle band is sloping up and the price is trading towards the upper band within the middle band, this is a sign of an upward trend. In this case, traders can wait for a rebound from the mid-band to open long positions.

LTC / USDT daily chart | Source: TradingView

The Litecoin (LTC) chart shows the start of an uptrend in mid-February 2019 as the middle band rose and the price traded between the middle and upper bands. Thereafter, traders can buy when the price recovers from the mid-band and holds the stop loss just below the swing low.

There are five entry options for traders. Four of them made attractive profits, but one of them triggered a stop loss. This shows that no strategy is perfect, so stop loss should be used to limit risk.

Daily SOL / USDT chart | Source: TradingView

Solana (SOL) dropped out of the upper band on September 1, 2020 and broke below the middle band on September 3, 2020. Since then, the price has remained largely in the lower area of ​​the BB indicator. This confirmed the downtrend and offered traders the opportunity to sell short on October 13, 2020 when the price was rejected from the mid-band and the downtrend continued.

Two Bollinger Bands can be used to track strong uptrends

One of the most profitable trading methods is to buy and hold in strong uptrends. This is easier said than done, however, as some traders are afraid to sell too early or wait for a deeper drop to buy.

This is where the Dual Bollinger Bands can come in handy. The use was shared by Kathy Lien, Managing Director FX Strategy at BK Asset Management.

To build the setup, traders use the default value for the first Bollinger Band indicator. For the second Bollinger Band, keep the value of the 20-period moving average, but reduce the value of the standard deviation of the outer bands by 1.

BTC / USDT daily chart | Source: TradingView

As mentioned above, in an uptrend, the goal is to buy when the price is trading between the upper band of the first and second Bollinger bands.

There have been some entry opportunities and traders should wait three consecutive days for the price to close between the upper bands before buying as this can help avoid unexpected swings.

Traders can keep the initial stop loss below the mid-band (SMA 20) but set it higher when the price hits a new key level to reduce risk and protect paper profits. One of the exit strategies is to sell when the price closes one standard deviation below the upper band of the Bollinger Band indicator.

The graphic above shows how the strategy is used. Traders could have entered on December 19, 2020 and continued to hold the position until a candle triggered the exit strategy on January 11, 2020. Another buying opportunity arose on February 7th and finally reached the exit point on February 23rd.

This strategy should be avoided when the price is fluctuating in a range and, to improve the chance of winning, traders should only open new positions when the price breaks a strong resistance level.

Important things

Bollinger Bands can be a good tool to help traders spot trends early by identifying volatility biases, which are often followed by an extension of volatility and a trend period.

Even if traders miss an early trading opportunity, Bollinger Bands can be used to take a position during a low risk pullback.

This indicator can also be useful for trading during times of strong trends when the corrections are flat.

There are several different ways you can use Bollinger Bands, and this article provides just a few guidelines for traders to use.

Traders can apply this knowledge to determine the current trend for Bitcoin.

SN_Nour

According to Cointelegraph

Follow the Youtube Channel | Subscribe to telegram channel | Follow the Facebook page