What is the default value of Bollinger Bands parameters? Why use 20 days?

Bollinger Bands are a popular technical analysis tool used by traders in the cryptocurrency market to assess volatility and potential price movements. Developed by John Bollinger, these bands consist of a middle band being a simple moving average (SMA) and two outer bands that are standard deviations away from the middle band. The default parameters for Bollinger Bands are set to a 20-day period for the SMA and two standard deviations for the outer bands. In this article, we will delve into the rationale behind these default settings, particularly focusing on the choice of a 20-day period.

Understanding Bollinger Bands

Bollinger Bands are designed to provide a relative definition of high and low prices. The middle band is typically a 20-day simple moving average, which represents the intermediate-term trend of the asset. The upper and lower bands are set at two standard deviations above and below the middle band, respectively. These outer bands adjust dynamically based on the volatility of the asset, expanding during periods of high volatility and contracting during periods of low volatility.

The Significance of the 20-Day Period

The choice of a 20-day period for the middle band is not arbitrary. It is based on extensive research and testing by John Bollinger, who found that this period strikes a balance between being sensitive enough to market movements and stable enough to filter out short-term noise. Here are the key reasons why a 20-day period is used:

• Intermediate-Term Trend: A 20-day period is considered to represent the intermediate-term trend of an asset. It is long enough to smooth out daily fluctuations but short enough to capture significant shifts in market direction.

• Historical Testing: John Bollinger tested various periods and found that 20 days provided the most reliable signals across different markets and timeframes. This period has been validated through backtesting and real-world application.

• Market Cycles: Many markets, including cryptocurrencies, exhibit cycles that can be captured effectively with a 20-day period. This period aligns well with the typical length of short to medium-term market cycles, making it useful for traders looking to capitalize on these movements.

Why Two Standard Deviations?

The outer bands of Bollinger Bands are set at two standard deviations away from the middle band. This setting is chosen to encompass approximately 95% of price action under normal market conditions. Here's why two standard deviations are used:

• Statistical Significance: Two standard deviations capture a significant portion of price movement, providing a clear indication of when prices are deviating from the norm.

• Volatility Measurement: By setting the bands at two standard deviations, traders can effectively measure and react to changes in volatility. When the bands widen, it indicates increased volatility, and when they contract, it signals decreased volatility.

• Trading Signals: The use of two standard deviations helps generate clear trading signals. Prices touching or crossing the upper band may indicate overbought conditions, while prices touching or crossing the lower band may indicate oversold conditions.

How to Set Up Bollinger Bands on a Trading Platform

Setting up Bollinger Bands on a trading platform involves a few straightforward steps. Here's how you can do it using a popular trading platform:

• Open the Chart: Launch your trading platform and open the chart of the cryptocurrency you wish to analyze.

• Add Indicator: Look for the option to add indicators. This is usually found under a menu labeled 'Indicators' or 'Studies.'

• Select Bollinger Bands: From the list of available indicators, select 'Bollinger Bands.'

• Adjust Parameters: The default settings will be a 20-day period for the SMA and two standard deviations for the outer bands. You can adjust these if needed, but for standard use, leave them at the default settings.

• Apply Indicator: Once you've confirmed the settings, apply the indicator to the chart. You should now see the Bollinger Bands overlaid on your price chart.

Practical Application of Bollinger Bands in Cryptocurrency Trading

Bollinger Bands can be used in various ways to enhance trading strategies in the cryptocurrency market. Here are some common applications:

• Trend Identification: By observing the direction of the middle band, traders can identify the overall trend of the cryptocurrency. An upward-sloping middle band indicates an uptrend, while a downward-sloping middle band indicates a downtrend.

• Volatility Trading: Traders can use the width of the Bollinger Bands to gauge market volatility. Narrow bands suggest low volatility, which may precede a significant price move, while wide bands indicate high volatility, which may signal a potential reversal.

• Price Reversals: When prices touch or cross the upper or lower bands, it can signal potential reversals. For example, if the price touches the upper band and starts to move back towards the middle band, it might indicate that the asset is overbought and due for a correction.

• Breakouts: Bollinger Bands can also help identify breakouts. If the price breaks above the upper band or below the lower band with strong momentum, it may signal the start of a new trend.

Customizing Bollinger Bands for Different Strategies

While the default settings of a 20-day period and two standard deviations are widely used, traders can customize these parameters to suit their specific trading strategies. Here are some ways to adjust Bollinger Bands:

• Short-Term Trading: For short-term trading, traders might use a shorter period, such as 10 days, to increase sensitivity to price movements.

• Long-Term Trading: For longer-term analysis, a period of 50 days or more might be used to capture broader market trends.

• Increased Sensitivity: Using a higher number of standard deviations, such as 2.5 or 3, can make the bands more sensitive to price movements, potentially generating more trading signals.

• Decreased Sensitivity: Conversely, using a lower number of standard deviations, such as 1.5, can make the bands less sensitive, which might be useful for filtering out noise in volatile markets.

Frequently Asked Questions

Q1: Can Bollinger Bands be used effectively in highly volatile markets like cryptocurrencies?

A1: Yes, Bollinger Bands can be particularly useful in volatile markets like cryptocurrencies. The bands adjust dynamically to changes in volatility, providing traders with clear signals about potential price movements. However, traders should be cautious and use additional indicators to confirm signals in such markets.

Q2: Are there any other technical indicators that work well in conjunction with Bollinger Bands?

A2: Yes, several indicators can complement Bollinger Bands. The Relative Strength Index (RSI) can help confirm overbought or oversold conditions indicated by the bands. Moving Average Convergence Divergence (MACD) can provide additional trend confirmation, and the Average True Range (ATR) can offer further insights into market volatility.

Q3: How often should I adjust the parameters of Bollinger Bands?

A3: The frequency of adjusting Bollinger Bands parameters depends on your trading strategy and the specific market conditions. For most traders, the default settings are sufficient, but you might consider adjusting them if you notice a significant change in market behavior or if you're switching between different timeframes or assets.

Q4: Can Bollinger Bands predict future price movements?

A4: Bollinger Bands are not designed to predict future price movements with certainty. Instead, they provide a framework for understanding current market conditions and potential price action based on historical data. Traders should use Bollinger Bands as part of a broader analysis and not rely on them as the sole indicator for making trading decisions.