How To Trade Bitcoin & Other Cryptocurrencies With Bollinger Bands
Anyone that trades securities should become familiar with technical analysis. This is especially important for someone that is interested in trading Bitcoin or other cryptocurrencies. There are many indicators or tools which can help one to project trends in the market. One of the most popular is known as a Bollinger Band. Investors have been using Bollinger Bands for many years to trade stocks, FOREX, and commodities. You can use this tool to trade Bitcoin, but first you will need to become familiar with Bollinger Bands and how to interpret them.
Becoming Friendly with Technical Analysis for Bitcoin
A few words are in order for the beginning trader before we talk specifically about how to trade Bitcoin with Bollinger Bands. There is a general presumption among new traders that technical analysis is very difficult to master. Some have an apprehension that prohibits them from learning more about these important tools.
We will not dispute that there is a learning curve when it comes to trading tools. The reality, however, is that the learning period can be fairly short for a person of average intelligence. The best way to overcome one’s intimidation is to obtain some historical charts or prior movements in the market. Study these charts and compare them to the price of Bitcoin during a given period. Soon you will be able to visually identify the existence of patterns in the complex looking graphs.
There is indeed complex mathematics involved in the creation of some charts. That doesn’t mean you have to be a mathematician to use them, anymore than you must be an electrician to flip on a light switch. What you are going to be doing is training yourself to recognize those all-important patterns. You don’t need any prior background in technology or even trading to learn how to use Bollinger Bands for trading Bitcoin.
What can be said with certainty is that the failure to use some type of trading tool or a combination of them will have a negative effect on your cryptocurrency trading. Without these tools you will be guessing. Trying to guess the movement of the crypto market is not that much different from gambling on a slot machine. Tools will allow you to make informed decisions and take calculated risks in your Bitcoin trading.
What are Bollinger Bands?
A Bollinger Band is a statistical analysis tool that was named after its creator, John Bollinger. John Bollinger is a famous technical trader who has authored books on the subject of financial investment. One of his most famous works is a treatise on using his Bollinger Bands profitably. Bollinger also produces a subscription newsletter for investors. He began the development of this statistical tool in the 1980’s.
Bollinger Bands use a mathematical formula to reflect prices and the volatility of securities. In one chart the tool displays bands that indicate moving averages for a security. The volatility of the security is expressed by the separation of the bands. This essentially combines two important points of analysis in one graph.
A user is able to specify certain parameters for Bollinger Bands, thus defining the range of historical data that is desired. It should be noted that longer periods of analysis always tend to produce a more accurate chart. Day traders will find the information from short-term Bollinger Bands to be less reliable than the information gleaned from longer-term inputs.
When a market is very volatile, the bands widen and become farther apart. When the market is relatively stable, the bands will narrow. Traders may be able to use Bollinger Bands to determine when a security is either overbought or oversold. Securities that encounter such conditions are likely to experience a price correction.
John Bollinger himself has stated that traders should not rely exclusively on his bands to trade securities. He recommends combining them with other technical analysis tools to provide confirmation of trading signals. Bollinger has specifically addressed Bitcoin and how his tool can be used to project the movements of the crypto market. He stated in one of his newsletters that Bollinger Bands could be a powerful indicator of crypto market trends. It is known that the tool can be applied to any type of security that is traded on an active market.
How Bollinger Bands Work in Trading Bitcoin
It is worth noting that Bollinger Bands are one of the few technical analysis tools whose creator has openly spoken about their effectiveness in Bitcoin trading. This should give the Bitcoin trader some encouragement about the reliability of this indicator. Bollinger draws comparisons between Bitcoin and the FOREX market. Many traders have been using the bands to trade FOREX for a long time.
Bollinger Bands plot the simple moving average, or SMA, of a security over a predefined period of time. A 21 Bollinger Band would be based on a 21-day SMA, a 10 band on a 10-day SMA, and so on. The trader can choose which period of time to define. Once the line of the SMA is plotted on the graph, bands appear above and below the line. These bands are what present trading signals. Here is an image of what Bollinger Bands look like for the S&P 500:
In this image you can see that the Bollinger Bands are placed on top of a regular candlestick chart. In the middle there is a blue line which represents a median SMA. The red and green lines above and below the blue line are the “bands” which traders can use to make investment decisions.
Traders can use the Bollinger Bands to identify the possibility of Bitcoin being overbought or oversold. If the candlesticks in the chart break below the lower band, this could indicate that Bitcoin is being oversold. If the break happens above the top band, this could me that the cryptocurrency is being overbought. Either situation could set up a trading signal or time to enter the market.
Notice on the chart above that the S&P experienced a lower breakout between the 11/08 and 12/08. A trader who was able to recognize a similar breakout with Bitcoin and enter a long position in the market could realize a substantial return in a short period of time. The same can be said when the breakout occurs above the top band. This would be the time to enter the market in a short position, or sell.
Another way to use the Bollinger Bands with Bitcoin is to project volatility. Cryptocurrency markets are known for being exceptionally volatile. Prices can vary a great deal in just a single day of trading. Volatility can present opportunities for the wise investor. When a cryptocurrency is volatile, there is money to be made. The widening of the Bollinger Bands reveals that the market is more volatile. A narrow band reveals that it is relatively stable.
Of course, volatility in cryptocurrency trading also carries a lot of risk. This is especially true for those who are margin trading. Not having enough margin to cover a trade and the failure to use stops will often lead to losing trades. In this case, using Bollinger Bands to reflect volatility could be helpful in alerting an investor when it is time to close trades and exit the market until things level out.
The Best Way to Approach Bollinger Bands with Bitcoin
Any form of technical analysis can be subject to error. The data may not hold water, and it is also possible for an individual to misinterpret trading signals. This is why John Bollinger recommends that traders use his tool in conjunction with other means of technical analysis. Other tools may be able to confirm what the Bollinger Bands reveal. Some of the recommended tools are:
- Relative Strength Index or RSI
- Stochastic charts
- MACD indicator
- Support and resistance
Serious traders generally take great pride in maintaining their charts. It is very easy today to keep charts on a computer for reference. There is no way to overstate how important historical analysis is to the trader.
Where to find Bollinger Bands for Bitcoin
Some services are available that will allow traders to purchase statistical charts for a fee. The fee can be quite high depending on the type of charting package one requests. It may be a better option for someone that is interested in trading to create an account with a cryptocurrency exchange. These exchanges will often provide the trader will free charts.
Once you have set up your account with the exchange, simply select the tools that you would like to use. You can implement them right into the trading platform for easy view. One word of caution. Some traders get addicted to tools. It is possible to use too many tools, rendering a simple chart into something that is unreadable.
Always remember that longer periods of historical data will produce a more reliable chart. You should opt for the longest collection period that your style of trading will support. Once you have learned to work within a specified time frame and also learned to spot patterns, your chance to make winning trades will improve.