Indicators are derivative of price meaning that the results that you see via a trading indicator will come via a calculation using the price you see on your chart. This is a long winded way of saying that all trading indicators including the Keltner Channel, is going to lag actual price movement.
It is the buying and selling by humans and computers although the trading programs are programmed by humans that will move price. As humans, we are susceptible to emotions and beliefs and emotions are even more vulnerable when money is on the line.
Channels, and this includes Bollinger bands and moving average envelopes, are theoretically designed to surround the general price action of the charted instrument.
One way to envision this general movement is consider that the price is travelling without an extreme bullish or bearish bias. While there may be an overall bias in one direction, there is nothing out of the ordinary with the movement of price. This is the time when you want to be on alert for potential trading opportunities as it is clear that volatility has increased. There are other things to consider but we can use the Keltner channel bands that surround price and the channels moving average as an alert for possible opportunity.
They are a measure of volatility in the case of the bands and consensus when referring to moving averages. Both price volatility when price is showing strong movement and when price is in balance are places for potential trading opportunities.
The average true range calculation of the Keltner shows us when there is an expansion in the price range of price which indicates some type of stimulus is hitting the market to move price. The Keltner channel is plotted with two outer bands and through the middle is a 20 period exponential moving average EMA. Using the moving average as an area of general agreement in price, we can see when price moves away from it that one side is favored over the other.
The further price moves away, the more we expect a snap back in the price. Like most indicators, there are inputs that you can change and that in itself can offer up a whole different set of problems. There are several settings we can change with the Keltner channel depending on your charting platform:.
The band multiplier is a very important number as it will determine how tight the outer and lower bands are to price. If the bands are tight, you may get a lot of excursions to the bands and beyond. This may be suitable for those scalping with the Keltner channel but not suitable for those looking for longer term plays in their instrument. Day trading is also a viable option with the Keltner channel and you can tweak the band multiplier to suit your trading needs.
There are those that often confuse the BB and KC but they do act differently in terms of reaction to price. The big difference is the Bollinger band is calculated using a standard deviation while the Keltner uses ATR average true range.
There is a slight difference between an exponential moving average and simple moving average in terms of sensitivity. The EMA will react quicker to any major move in price. When price moves out of congestion range as this example shows, the bands stretch far from price. The Keltner Channel on the other hand is smoother which makes it easier to spot trends in the market.
Some traders utilize the Bollinger bands and the Keltner channel together to show a Bollinger Band Squeeze. When the Bollinger is inside the Keltner, the squeeze is on. This indicates a trading range is occurring.
As a trade setup, the movement of the bands outside of the channel is the trigger. This would indicate that the price is potentially about to go on a run as price breaks from the trading range.
Whether you are going to use the Keltner channel or Bollinger Bands for this trading system, is not the point. You can use either because it is the concept we are looking at.
The original Keltner used a 10 period for the moving average but it caused traders to be whipsawed around far too much. Over time, the popular setting became a 20 period EMA, a 20 period average true range and a 2. These settings were brought to use by Linda Bradford Raschke. You can of course test various settings but in the end, we are simply looking for price engaging with either of sides of the channel.
Trading pullbacks is best done in a market that has exhibited a strong push in a direction in a trending market. This is based on swing analysis where you want to see conviction in a market swing that indicates another move in the same direction. Using the Keltner channel, we can use price travelling outside the bands as an indication there was conviction in the swing.
Even a shadow plot is sufficient if you are a more aggressive trader. When price is at the channel, that is an alert to look for a pullback in the price to an area around the 20 period EMA. Highlighted by the orange color, you can see that price has traveled outside of the channel. This is the first sign that we may have a trade if the pullback fits other criteria.
Not all excursions equaled a pullback into the zone around the moving average and as you can see that at times, price traveled along the channel. That issue will be covered in a later trading tips segment. We would like to see price pulling back not only to the mid-line but also to a price structure or exhibiting a topping pattern. This is called confluence and can actually increase the probability of your trade getting some traction.
We need a trigger to get into the trade and there are many tools that you can use. Momentum indicators are a popular method as well as the very basic trend line.
This chart is a factor 4 less than the previous chart. By using a smaller time frame to get into the trade, you may be able to get a better position sizing as you position yourself higher in the curve to the downside in this example. The black dotted lines on this chart are boxing off structures of possible resistance that coincide with the pullback to the mid-line.
These potential zones of trading opportunity that includes the structure are from the trading chart and I encourage you not to use the trigger chart to find the structure. Before continuing, the area marked three may have some questions. It is a sloppy complex pullback because the second leg did pierce the bottom of the first before reversing from what may be considered a double bottom. Where this gets interesting is the second leg matches in distance the first leg of the move.
This is called symmetry and many traders will utilize this as a stand alone trading system. Price also exhibits a topping pattern, a double top and you can see from this chart that a confluence of factors were in play when price broke solidly to the downside. I am using standard trend-lines to show the counter-trend move in price which brings us to our setup zone.
You may use a standard break of the trend-line for your trade entry. Some traders like to target opposing structures while others would like a more objective means to find profit targets. Fibonacci was my original method of trading when I first started and have since refined things since the early days.
The fact that we are trading pullbacks makes it easy to find our targets with Fibonacci in a way that is completely objective. We are going to take the move into the extreme of our pullback and project forward in time to a potential price target. Here are the numbers that I personally use and will use for this example. Note that is omitted but I use it for targeting after a range. You can see the total pips for each trade in green for a combined total of pips Forex example before spread costs.
These targets are shown on the trigger chart for detail. You still have to put in the work in determining the overall trend direction, when counter trend trading is appropriate, extent of excursion plus the very important account management and risk profiles. There are also other trading opportunities that Keltner channel trading may provide and I will cover some of those in a later post. A lot of work goes into designing a full trading plan including back testing and forward testing.
Contact our trading coaches and see how Netpicks can help you on the road to successful trading. Channels Measure Price Extremes It is the buying and selling by humans and computers although the trading programs are programmed by humans that will move price.
Channels can show deviation from normal price behavior Channels, and this includes Bollinger bands and moving average envelopes, are theoretically designed to surround the general price action of the charted instrument. The bands do not act as a physical barrier to price just as moving averages do not magically support price.
Moving Average Consensus The Keltner channel is plotted with two outer bands and through the middle is a 20 period exponential moving average EMA. Keltner Channel and Moving Average Using the moving average as an area of general agreement in price, we can see when price moves away from it that one side is favored over the other.
Keltner Channel Settings Like most indicators, there are inputs that you can change and that in itself can offer up a whole different set of problems. There are several settings we can change with the Keltner channel depending on your charting platform: You can visually see how Bollinger bands reacts differently with sudden price shocks.
Price Channel Trading Plan The original Keltner used a 10 period for the moving average but it caused traders to be whipsawed around far too much. Pullback Trading Trading pullbacks is best done in a market that has exhibited a strong push in a direction in a trending market. An excursion outside of the channel indicates an extreme from what was a considered normal price action. This chart shows a down trending market in play.
Price moves to channel extreme Not all excursions equaled a pullback into the zone around the moving average and as you can see that at times, price traveled along the channel. Valid and invalid price excursion to channel extreme We now have three definite pullbacks that met our criteria of: A price cross of the average does not invalidate the trade setup. Obvious trending market as shown by the slope of the channel and moving average.
Trend lines and Keltner Channel trading strategy The black dotted lines on this chart are boxing off structures of possible resistance that coincide with the pullback to the mid-line.
Stop placements could go either above the turn or above the zone that has acted as resistance. Trade Targets We are going to use the setup chart for targets and like trade entries, you have a few options. I used the bottom of the structure range for the entry price. The following two tabs change content below. CoachShane Trader at Netpicks. Shane his trading journey in , became a Netpicks customer in needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading.
This has allowed less time in front of the computer without an adverse affect on returns.More...