What are Bollinger bands
John Bollinger, an American writer, and financial analyst is best known for his technical indicator, the Bollinger Bands, that measures whether prices move too far from a moving average, and therefore from a volatility indicator.
There are 3 lines on this indicator. In the middle is a moving average (20 by default), while the upper and lower lines represent the standard deviation from this moving average (generally +2 and -2 times the standard deviation).
When prices move away from their moving average, the bands move away from each other, which is a sign of volatility.
Conversely, when the bands are tightened, it indicates price indecision, with prices generally fluctuating within a range.
With a moving average setting of 20 periods and a standard deviation of +2 / -2, prices change 95% of the time between bands. The further apart the bands are, the higher the volatility. Let us look in more detail the 4 phases of this indicator.
There are 4 distinct phases for Bollinger bands:
–> Phase 1: tightening of the bands: volatility is low, and this generally precedes an “explosion” of volatility
–> Phase 2: the bands move away and move in opposite directions. Volatility increases and a trend phase begins.
–> Phase 3: the upper (or lower) band changes direction and both bands now move in the same direction. This may be a sign that the movement is weakening and that a high/low point may have been hit.
–> Phase 4: the upper (or lower) band changes direction at all and the bands start to tighten. Volatility is beginning to decrease, and it is likely that a range will be prepared (phase 1).
Phase 1: low volatility
Phase 2: volatility explosion
Phase 3: volatility still present but less pronounced
Phase 4: Volatility is reduced and prepares for Phase 1.
Example of the different phases on the Bollinger bands on BTC.
There are different ways to trade with this indicator. Generally, traders like to take a position when the bands are tightened (phase 1) because this is often an indication of future volatility, and therefore of probable profits if the position is taken in the right direction.
Example of a position statement: whenever volatility decreases (the bands are tightened –> Phase 1), it was possible to go short as this was an indication of an increase in volatility in the future. Obviously, we would have liked to trade in the direction of the general trend and therefore rather bearish.
Very popular with traders, Bollinger bands are a highly responsive technical volatility indicator, making them a very useful tool for scalping / intra-day strategies.
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