Keltner channels like Bollinger Bands are volatility based envelopes set above and below a moving average (mostly exponential). While BB uses standard deviations, KC uses a multiple of ATR for the bands. This is the version (by Linda Bradford Raschke) which is used commonly in most software. Chester Keltner’s original calculations were different.
KC is mainly a trend following indicator and helps in trading in following ways
- Trend Determination - trend is normally in the direction of the channel.
- In strong trends, they help in identifying the break-outs. Any strong move outside the band in the direction of trend signals strong breakout.
- During trading ranges, they help in identifying over-bought/over-sold areas.
- In downtrend, when channel turns up breaks above a bear trend line, it is an early signal of trend reversal. Same logic would apply to channel turning down below bull trend line.
- John Carter combined KC and BB to create a Squeeze indicator which is a very good breakout indicator. In this first BB have to contract enough so that their range comes entirely within the KC range. Then when the BB start expanding and move outside the KC, it indicates a violent move.
One of the main advantage of KC over BB is that it is more smoother and hence gives a better indication of trend direction.