TL;DR
- Bollinger Bands are a technical indicator that can measure the volatility of financial assets like cryptocurrencies.
- Bollinger Bands indicator is composed of three lines: the upper band, the lower band, and the moving average center line.
- Simple Moving Averages (SMA) and Exponential Moving Average (EMA) lets trader know how the trending is moving.
- Compared to simple moving averages, the exponential moving average is faster at adjusting to unexpected movements, breakouts, and reversals.
- The EMA line can be used as a point of support and resistance.
- When using the EMA, keep an eye for the death cross (a bearish signal) and the golden cross (a bullish signal).
In This Article
Technical analysis is one of the most powerful methods of predicting the optimal time to enter or exit positions in crypto trading. Using technical indicators, experienced investors are able to evaluate market data, allowing them to make near-accurate trend predictions.
In this article, let’s explore two technical indicators that can help you predict price trends and formulate winning strategies. Let’s take a look at Bollinger Bands (BB) and Exponential Moving Averages (EMA).
Bollinger Bands Explained
The Bollinger Bands is a technical indicator that can measure the volatility of financial assets like cryptocurrencies. The bands are calculated using the standard deviation of a moving average. Standard deviation is a statistic used in probability theory and is commonly applied in financial markets to measure volatility.
To calculate Bollinger Bands, the 20-day simple moving average is typically used because it averages out the closing prices for the first 20 days as the first data point. Bollinger Bands are typically plotted two standard deviations above and below the mean value. This means about 95% of a crypto's historical price movement is likely contained within the two bands.
With this information, we can add context to trends and potentially determine when they might be overextended and reversed. Because the bands typically contain about 95% of the asset’s price movement, it’s unusual for the price to move outside the bands. When it does, probability theory suggests that asset prices will ultimately return to their mean value.
This is called Mean Reversion, and some investors use it to make important trading decisions.
How to Trade with Bollinger Bands?
Let's make some examples of how you may be able to determine entry and exit points using a Bollinger Bands
Closing Price Near the Upper and Middle Bands
When the price drops below the lower band, it is a good time to wait. During this time, investors are on the lookout for opportunities to buy when the price touches the lower band again. This reversion serves as a confirmation of the prevailing trend. Some investors may also use it to close their positions. Others may refer to the upper band as the point of exit, which is typically set with a greater profit target and a longer timeframe.
Traders who use the Bollinger Bands wait for confirmation by allowing the price to cross above the upper band. When the price falls below the upper band, it is advisable to sell because the mean-reversion theory is at play.
Confirmation Based on the Slope of the Bands
Some investors look for additional confirmation by considering the slope of the bands. If the bands are sloping up, then the market is in a potential uptrend. Conversely, if the bands are sloping down, the market is in a potential downtrend. By referring to the slope, some investors might only take the entry points in uptrends and ignore the ones in potential downtrends. Timing entry and exit points in these ways are one of the main benefits of applying Bollinger Bands.
The Bollinger Bands indicator can also gauge the intensity of an upward or downward trend.
Uptrends
The Bollinger Bands indicator can gauge the intensity of the rally and the time it may change direction. If the uptrend is strong, the price may touch the upper band more frequently. If the momentum hits the upper band, it's likely that investors will maintain their strong stance and the price will keep climbing.
During an uptrend, prices should avoid falling under the lower band. Otherwise, a reversal could be just around the corner.
Downtrends
In a strong downtrend, the Moving Average will approach the lower band. This is attributed to the increase in selling pressure. When the price stops hitting the lower band and starts moving alongside it, it's a clear sign of an impending reversal. In such circumstances, short positions should be closed as soon as possible.
If the price crosses or breaks above the upper band during a negative market, an imminent reversal could happen. Many investors avoid this period because most cryptocurrencies could surge at any moment. The only reason they keep an eye on the bears is to buy the dips at the support level.
Things to Look out for When Using Bollinger Bands Indicator
The biggest flaw of Bollinger Bands is deviations that might linger for a long time. Every time the price dips below the lower band, traders and investors generally wait to enter the market because further price drops are possible during this period. But at the end of the day, the mean-reversion theory doesn't always hold in the real world.
When trading, Bollinger Bands cannot be used alone as a reference. It is most effective when used in combination with other Technical Analysis Indicators.
What is a Moving Average Indicator?
Moving averages are indicators that are put on candlestick charts to determine the average value of a cryptocurrency over a given time period. For example, the 100-day exponential moving average (EMA) shows the average value of crypto over the last 100 trading days. Although various kinds of technical indicators fall under the moving average trading strategy, they can be roughly divided into two types: simple and exponential.
Using Exponential Moving Averages in Crypto Trading
Compared to simple moving averages, the exponential moving average is faster at adjusting to unexpected movements, breakouts, and reversals. Exponential moving averages (EMA) can quickly reflect the latest price movements. In addition, it may show you where to find levels of resistance or support, guiding your trade timing before opening or closing positions.
When the price is lower than its 200-day EMA, the asset could encounter some difficulty when it reaches the 200-day EMA. On the other hand, the 200-day EMA functions as a reliable reference for the support level when the price reaches above this line.
On the other hand, the EMA can act as a resistance level similar to a traditional horizontal resistance level. To test this, you can observe how the price bounces back when it touches the EMA line. When you confirm such a pattern, you can use it to trade accordingly.
When using an exponential weighted moving average, professional traders always keep an eye out for two crucial patterns:
The Death Cross
When a short exponential moving average (example: 20-day EMA) overlaps with a long EMA (example: 200-day EMA) from above, the result is called the "death cross." It indicates an imminent surge of selling pressure and a prolonged downtrend.
The Golden Cross
The “golden cross” is formed when a narrow MA indicator (like a 20-day EMA) overlaps with a longer MA indicator (like a 200-day EMA) from underneath the moving average chart. This formation indicates that bullish sentiment is just around the corner.
Cautions When Using EMA
Short-term traders often prefer EMAs over SMAs because EMAs are better at spotting changes in price quickly. However, it’s important to determine the type of moving average indicator that matches your own trading methods and goals.
The EMA is generally trusted, but it does have several shortcomings that investors in cryptocurrencies need to be aware of. For starters, it can't be used as a sole indicator to find the optimal entry or exit points. For optimal results, the EMA is best used in conjunction with the RSI and the ADX (ADX).
Although the indicator is widely praised for its speed in reflecting current price activity, it does have a slight lag. Therefore, the EMA cannot immediately detect sharp price surges or declines. If the EMA is used when the market is very volatile, it might not give accurate results.
Trading Safe
When it comes to making trading decisions, many short-term traders base their decisions mostly on the technical analysis side of crypto trading. Conversely, there is another group of traders who exclusively concentrate on fundamental analysis. But the best way to trade is by using both fundamental and technical analysis to give you a clearer picture of the market.
Technical analysis gives information about how the market moves and how prices change. On the other hand, fundamental analysis is a good way to plan for long-term investments. Both these types of analysis can help you make informed financial decisions and formulate effective strategies.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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