How to use the short-term indicator Bollinger Bands?

What is 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 tool in technical analysis (TA); fundamentally, it is an oscillation measure used to indicate the high and low volatility 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 an average value. More specifically, the indicator consists of an upper band, a lower band, and a middle moving average line (also known as the middle band). The two horizontal bands respond to market price behavior, expanding when volatility is high (moving away from the middle band) and contracting when volatility is low (moving towards the middle band).
The standard Bollinger Bands formula sets the middle band as the 20-day simple moving average (SMA), while the upper and lower bands are calculated based on the market volatility associated with the SMA (known as the standard deviation). The standard configuration of the Bollinger Bands indicator is as follows:
Middle track line = 20-day moving average line (SMA)
Upper Band = 20-day SMA + (20-day Standard Deviation x 2)
Lower Band = 20-day SMA - (2 x 20-day Standard Deviation)
The standard Bollinger Bands use a 20-day period, setting the upper and lower bands two standard deviations (x2) away from the middle band. This is done to ensure that at least 85% of the price data will fluctuate between these two bands, but the settings can also be adjusted according to different needs and trading strategies.
How to use the Bollinger Bands indicator in trading?
Although Bollinger Bands are widely used in traditional financial markets, they can also be applied in the cryptocurrency trading system. There are various methods to use and analyze Bollinger Bands, but one should not treat them as an independent tool or view them as indicators of buy/sell opportunities. Instead, Bollinger Bands should be used in conjunction with other technical analysis indicators.
Considering this, let's think about how people 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 can generally be safely assumed that the market is currently in a state of excessive expansion (overbought condition). On the other hand, if the price touches the upper band multiple times, it may indicate a significant level of resistance.
Conversely, if the prices of certain assets significantly decline and repeatedly fall below or touch the lower bound, the market may be in an oversold state or have reached a strong support level.
Therefore, traders can use Bollinger Bands (as well as other TA indicators) to set their sell or buy targets, and likewise, they can have a general understanding of the overbought and oversold conditions in the market.
In addition, when trying to predict the moments of high and low price fluctuations, the expansion and contraction of the Bollinger Bands indicator can be useful. The bands move away from the middle line (expansion) when the asset price fluctuates significantly, or move towards the middle line (contraction) when the price fluctuations weaken.
Therefore, the Bollinger Bands indicator is more suitable as a tool for analyzing market volatility and attempting to predict upcoming trends in short-term trading. Some traders believe that when the bands are excessively expanded, the current market may be approaching a consolidation phase or about to reach a trend reversal. Similarly, when the bands are too narrow, traders believe that a significant market movement is about to occur.
When the market price moves sideways, the Bollinger Bands tend to narrow towards the middle simple moving average. Typically (but not always), low volatility and small deviation levels occur before a large explosive movement, and this phenomenon happens once the volatility rebounds.
Bollinger Bands Indicator vs Keltner Channel
Unlike the Bollinger Bands based on SMA and standard deviation, the modern version of the Keltner Channel (KC) indicator uses the Average True Range (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 track line = 20-day Exponential Moving Average (EMA)
Upper Band = 20-day EMA + (10-day ATR x 2)
Lower Band = 20-day EMA - (10-day ATR x 2)
Typically, the Keltner Channel presents tighter bands than the Bollinger Bands. Therefore, it may be more suitable than the Bollinger Bands for indicating trend reversals and overbought/oversold market conditions in a clearer and more obvious manner. In addition, the Keltner Channel indicator usually provides earlier overbought/oversold signals than the Bollinger Bands.
On the other hand, Bollinger Bands can better represent market volatility because their expansion and contraction movements are larger and more pronounced compared to Keltner Channels. Additionally, by using standard deviation, the Bollinger Bands indicator is less likely to provide false signals, as its width is larger, making it difficult to be breached (upper and lower bands).
Compared to the Keltner Channel, Bollinger Bands are more popular. However, both indicators are good—especially for short-term trading setups—and both can also be used in conjunction to provide more reliable (market) signals.