Explanation of the Bollinger Bands Indicator

The Bollinger Bands (BB) indicator was created in the early 1980s by financial analyst and trader John Bollinger. The Bollinger Bands Indicator is widely used in the field of Technical Analysis (TA) as a (financial analysis) tool, and is basically an oscillator that is used to indicate 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 the average. More specifically, the indicator consists of an upper rail, a lower rail, and an intermediate moving average (also known as a mid-rail). The two horizontal bands react to market price behavior, expanding (running away from the mid-rail line) when volatility is high and contracting (running towards the mid-rail line) when volatility is low.

The standard Bollinger Bands formula sets the center line as a 20-day Simple Moving Average (SMA), while the top and bottom rails are calculated based on the market volatility (called the standard deviation) associated with the SMA. The standard configuration of the Bollinger Bands indicator is shown below:

Middle rail = 20-day moving average (SMA)

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

Lower rail = 20-day SMA — (20-day standard deviation x 2)

The standard Bollinger Bands are set on a 20-day cycle with the upper and lower bands set two standard deviations (x2) away from the center rail line. This is done to ensure that at least 85% of the price data will fluctuate between these two bands, but the size of the setup can be adjusted to suit different needs and trading strategies.

How can I use the Bollinger Bands indicator in my trading?

Although Bollinger Bands indicators are widely used in traditional financial markets, they can also be used in the cryptocurrency trading system. There are various ways to use and analyze the Bollinger Bands indicator, but one should not treat Bollinger Bands as a stand-alone tool or view them as an indicator indicating buying/selling opportunities. Instead, Bollinger Bands should be used in conjunction with other technical analysis indicators.

With this in mind, let’s think about 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, it is probably safe to assume that the market is overextended (overbought) at this point. On the other hand, if the price touches the upper rail several times, it may indicate a significant level of pressure.

On the contrary, if the price of certain assets falls significantly and exceeds or touches the lower rail several times, the market is probably oversold or has reached a strong level of support.

As such, traders can use Bollinger Bands (and other TA indicators) to set their sell or buy targets, and similarly, they can get a general idea of what is overbought and oversold in the market.

In addition, the expansion and contraction of the Bollinger Bands indicator may be useful when trying to predict moments of high and low price volatility. The bands will run away from the mid-rail line (expanding) as the asset price fluctuates violently, or towards the mid-rail line as the price fluctuations become weaker (contracting).

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

When market prices move sideways, the Bollinger Bands tend to narrow towards the simple moving average in the middle. Often, but not always, low volatility and small deviation levels will precede a large explosive movement, which will occur once volatility picks up.

Bollinger Bands vs Kentner Channel

Unlike Bollinger Bands, which are based on the SMA and Standard Deviation, the modern version of the Kentner Channel (KC) indicator utilizes the Average Range Transformer (ATR) to set the width of the channel above and below the 20-day Exponential Moving Average (EMA). Thus, the formula for the Kentner Channel looks roughly like this:

Middle rail = 20-day exponential moving average (EMA)

Upper rail line = 20-day EMA + (10-day ATR x 2)

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

Typically, the Kentner Channel will show tighter bands than the Bollinger Bands. As such, it may be better suited than Bollinger Bands to point out trend reversals and overbought/oversold market conditions in a clearer and more obvious manner. In addition, the Kentner Channel Indicator usually provides an earlier overbought/oversold signal than Bollinger Bands.

On the other hand, Bollinger Bands provide a better representation of market volatility because it expands and contracts in a much larger and clearer range of motion than Kentner Channels. In addition, through the use of standard deviations, the Bollinger Bands indicator is less likely to provide pseudo-signals because its width is more