BB ATR and Keltner are top 3 volatility indicators you should start using right now!
For much of the trading community, markets are a struggle for dominance between two opposing forces: direction and volatility. Most indicators tell you where price may go but it’s the latter that determines your success or failure. Volatility is simply a measure of how much and how quickly an asset’s price moves up and down. If you ignore it, you in danger of being stopped out by normal market noise or not riding the full potential of a serious breakout.
By understanding what volatility is, you can adapt your strategy to the current “personality” of the market. It allows you to place more intelligent stop losses, discover profitable profit targets and know when a low-volatility market is about to burst into action.
In this writing, we will discuss three key volatility indicators and how you can use them: Bollinger Bands, Average True Range (ATR), and Keltner Channels. You will learn what they are, how they differ from each other and how you can use them to enhance your trading plan.
1. Bollinger Bands®: The Dynamic Support & Resistance Gauge
It is one of the most widely used technical analysis tools and was developed by John Bollinger. It consists of three lines:
- Middle Band: 20-period Simple Moving Average (SMA).
- An Upper Band: The Middle Band plus two standard deviations.
- A Lower Band: The Middle Band – two standard deviations.
What It Shows: Bollinger Bands measure the volatility using standard deviation, a statistical concept that tells you how spread out the data is away from its average. The bands expand when volatility increases and narrow when it decreases.
How to Use It:
The Squeeze (Identifying Which Stocks are Set to ‘Bleed’ out): This is the best Bollinger Bands signal. If the bands bend strongly inwards, it signals an extremely low volatility phase (compare the analogy with a coiling spring). A “squeeze” means that the market is contracting and consolidating downward or building energy for a massive breakout. The direction of the eventual breakout, Either above the upper band or below the lower band, is a signal indicating a correct trade.
Dynamic Support and Resistance:Undoubtedly, the upper band works as a dynamic resistance while the low… Traders may sell when the price hits the upper band and purchase when it reaches the lower band. Perhaps the most important thing to understand about the bands is that in a trending market, price often “walks” or hugs the band – riding on the upper band in an uptrend and the lower band in a downtrend – which causes reversal signals to become less effective.
Overbought/Oversold Context (caveat here): A touch of the upper band indicates an overbought asset and a touch of the lower band can indicate an oversold one. But that is not a one-time reversal signal. It has to be put in relation to the overall development. In a strong uptrend, tagging the upper band over and over is not selling for sure.
2. Average True Range (ATR): The Absolute Volatility Measurer
If Bollinger Bands measure spread in terms of a moving average, the Average True Range (developed by J. Welles Wilder Jr.) measures the absolute spread. It doesn’t tell you the direction of price, just the amount by which a given asset is likely to move.
The ATR is based on the ‘True Range,’ which assesses gaps between periods by comparing:
- Current High minus Current Low
- Current High minus Previous Close (absolute value)
- Current Low minus Previous Close (absolute value)
The ATR is then a moving average (typically 14-period) of the True Range.
What It Is: The ATR provides you with an average trading range of an asset, in the form of points or pips, over a defined period of time (daily, weekly, monthly). A high ATR indicates that daily ranges (volatility) are large. A low ATR indicates a period of small range and low volatility.
How to Use It:
Adjusting stop-losses for Volatility: This is the ATR’s user friendly approach. Rather than using a hard, arbitrary level for our stop-loss (i.e. placing the stop at 20 pips) you can put that risk based on what is happening in the market right now. A popular approach many traders use is to slot in their stop-loss a 1.5x or 2x the 14-period ATR from the price off their position. For a low volatility stock this might be 50¢; for a high volatility crypto it could be $200. This will place your stop logically beyond the market’s normal “noise.
How to Place Profit Target on A Daily Chart The best way to place your stops and profit targets on a daily candlestick Time-Frame is using the average true range. For instance, if you go long, your target would be Entry Price + (2 x ATR). It involves setting a profit target that is based on the asset’s volatility, which makes more sense.
Validating Breakouts and Strength: A breakout off a consolidation pattern with an ATR surge is a much more powerful, reliable signal than that of a breakout on low ATR. Our rising ATR tells us that there is new energy added to the move.
3. Keltner Channels: The Trend-Following Volatility Envelope
Keltner Channels Keltner Channels are once again a visually similar to Bollinger Bands but they have their internal logic. They also come in 3 lines:
- A Middle Line: A 20-period Exponential Moving Average (EMA).
- An Upper Channel Line: The Middle Line plus a multiple of the ATR (typically 2x the 10-period ATR).
- A Lower Channel Line: The Middle Line minus the same multiple of the ATR.
What It Is: Keltner Channels place a volatility-based envelope around an EMA using ATR. Since the ATR is smoother compared to standard deviation, and the EMA is more responsive compared to an SMA a Keltner Channels are typically tighter and smoother when compared with Bollinger Bands.
How to Use It:
The Squeeze and Trend Recognition: Just like Bollinger Bands, when the Keltner Channel becomes extremely narrow, it is a signal that the volatility is low and there could be a “squeeze”. But trend-following is usually believed to be best done with Keltner Channels.
Signal “Channel Walk”: A healthy, robust trend generally leads to price closing most of the time outside the Keltner Channel. When a number of consecutive closes occur above the upper channel, it is a very strong indication that price movement is going into an uptrend; when they move below the lower channel, there are strong indications of downtrends. That is the reverse logic of Bollinger Bands’s mean-reversion play and it makes the Keltner Channels very good for catching strong trends.
Mean Reversion in Ranges: In a non-trending unfavorable market the top as well as the bottom of channels can offer support and resistance. Fade the moves, selling near top of channel and buying near bottom of channel (stop just outside the channel).
Putting It All Together: A Cohesive Volatility Strategy
These indicators are each powerful on their own, but they really shine when used together.
Sample Strategy: The Confirmed Breakout
Find the Squeeze: Be patient until both the Bollinger Bands and Keltner Channels start to narrow together – this highlights a state of extreme compression.
Watch for the Break: A bullish close with strength which has closed outside of the Keltner Channel.Look to Buy on Pullbacks.
With Volume and ATR Confirmation The breakout candle also needs to have a big increase in volume, this is the volatility expansion confirmation.
Manage the Trade: Use the ATR as a guide to setting your initial stop-loss (e.g., 1.5 x ATR below the low of the breakout candle for a long trade). You could subsequently use the Keltner Channel upper or lower line as a trailing stop to ride the new trend for all it is worth.
Conclusion: From Guessing to Knowing
Volatility isn’t something to fear; it is a quantifiable aspect of the market. When you use Bollinger Bands, the Average True Range, and Keltner Channels in your analysis, suddenly guessing where stops and targets should be falls by the wayside for data-driven decisions.
Bollinger Bands for showing compressions and range dynamic S/R.
Utilize the ATR to subjectively place your stop loss orders or profit targets, reflective of the market’s current scope.
Trade the start and end of strong trends with Keltner Channels.
By mastering these three indicators you are giving yourself a huge edge with your new advantage of being able to trade the market’s rhythm and not just the direction, but also trading momentum.