Keltner channel and squeeze
The Keltner channel is a band drawn around the average price based on the average height of the candles. When Bollinger bands enter the Keltner channel, volatility has unusually decreased: this is called a squeeze and is often seen before a big move.
In the chart above, you see two pairs of lines around the price. The orange lines are the Keltner channel, the pale gray lines are the Bollinger bands. Watch the areas where the gray lines enter the orange ones; when the system finds a squeeze, it marks that range with a shaded area between the bands.
Although the two bands look similar, they measure different things. Bollinger bands are drawn based on the standard deviation of closing prices: they narrow very quickly when the price calms down, and expand rapidly during sharp movements. The Keltner channel, on the other hand, is drawn around the 20-candle average price, based on the average height of the candles, and moves more slowly and smoothly.
A squeeze is when the Bollinger bands enter INSIDE the Keltner channel. This means that volatility has unusually decreased: the price is quiet even compared to the normal height of the candles. Silence in the markets is usually not permanent. Volatility remains low for a while, then expands in one direction. Therefore, a squeeze is watched as a harbinger of a big move.
But a squeeze does not indicate direction. After the silence, the price can explode both up and down. The moment the squeeze ends, that is, when the Bollinger bands move out of the Keltner channel again, indicates that the movement has begun; its direction is determined by the breakout at that moment.
The Keltner channel is also used outside of squeezes: in strong trends, the price moves in the upper half of the channel, and pullbacks to the middle line are watched as buying zones. A close outside the channel is a sign of an unusually strong move.
How to read it
- Look to see if the gray Bollinger lines have entered the orange Keltner lines; if so, there is a squeeze.
- Do not predict direction while the squeeze lasts; just be prepared and identify levels.
- Watch the candle where the squeeze ends and the direction of the breakout; the breakout determines the direction.
- Place the stop on the other side of the band opposite the breakout.
In this state right now
Currently, the most liquid symbols with the narrowest bands on the daily chart (Bollinger band width less than 5% of the price).
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Trap
The most common mistake is to mistake a squeeze for a directional signal. A squeeze says 'something is about to happen', not 'it will go up'. The second trap is trying to predict how long a squeeze will last: quiet periods can last much longer than expected, and capital waits idle during this time. The third is blindly following the first move when the squeeze ends: the initial breakout is sometimes false, and the price immediately reverses.
Tip
The band contraction in the Bollinger lesson and the squeeze in this lesson are two measures of the same idea. There is a scan among the scans that finds symbols quietly accumulating with low volatility; you can add what it finds to your watchlist and wait for the breakout.
Glossary
- Keltner channel
- A band drawn around the average price based on the average height of the candles.
- Squeeze
- When Bollinger bands enter the Keltner channel; indicates that volatility has unusually decreased.
- Volatility
- A measure of how sharply and widely the price moves.
- Expansion
- The rapid opening of the bands after a squeeze; the moment the movement begins.
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