Keltner Channels

Keltner Channels Explained

Keltner channels are a form of technical analysis that is quite useful. What is a Keltner channel? It’s a volatility-based indicator in stock trading composed of three separate lines. They use the average true range (ATR) instead of the standard deviation with Bollinger bands. Bollinger bands are also a great momentum tool that can be used to scalp.

Keltner channels are volatility-based envelopes below and above ema‘s or exponential moving average lines. Instead of using the standard deviation with Bollinger Bands, they use the ATR or Average True Range.

Trading the market these days requires adapting to new situations and finding new trading strategies. Typically, these are different from the market strategies used in the past. During one strong surge in the market, the $SPY broke out in the chat room, and a trader suggested they would like to find an entry during the next pull-back.

Keltner Channels Pullback

Common intraday tactics are finding a ticker presenting momentum in the analysis. Then, could you wait for a pullback and pull the trigger? These are rare trading days.

As a result, in strong accumulation days, a very liquid ticker like $SPY can run wide open to the next level of resistance, only to turn around and fall back all the way to support again as the surging momentum is played out the trader who suggested waiting for an entry was not wrong. I commend them for not ‘chasing’ a trade. It’s important to realize that current market conditions suggest a different strategy be developed to take advantage of these surges.

There are a lot of different trade strategies to deal with different markets. One strategy, which has always been a favorite of mine, has some basic characteristics that I have adapted to use in these situations.

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Keltner Channel Moves

Price Headly has a daily market trade strategy that utilizes the Bollinger bands study with the acceleration bands study to identify a ticker with such momentum that the price breaks outside of the acceleration bands.

The move is so strong and sudden that the Bollinger bands follow the price outside the acceleration bands. In the strategy, his trade concept was that a strongly trending stock with that much momentum would continue to trend.

Otherwise, it will quickly lose momentum and fall back inside the acceleration bands study. Thus, it offers the trader a simple trade strategy with nicely identified stop-loss criteria.

Modifications

If we modify this strategy for intraday trading, we can identify trade set-ups that present momentum. Then, they will have a clearly defined stop loss to take advantage of these market surges. You won’t need to worry about jumping into a trade with no longer the momentum to continue higher. Our criteria are simple:

  • Identify when a trending stock still has momentum to allow a ‘late’ trader an opportunity to participate in the rally while still utilizing a respectable stop-loss plan.

Activate and utilize an indicator or study that works, is respected by the trading community, and can be used by traders from all skill levels.

Keltner Channels

Breakdown

Allow me the opportunity to present the Keltner Channels. Anyone can look back after the day and highlight great entries and exits. However, let’s take the time now to examine these three trade setups. I believe that this analysis may offer some perspective.

We are right after the bell, and the price has consistently closed outside the Keltner channel’s top band. I only trade the open bell sometimes. I do not recommend that anyone ever trade the open range (OR) without a very clear grasp of trading the open.

Set that aside. The price may be closed outside of the Keltner channel’s top band. However, the price is OPENING inside the Keltner channel. This keeps me out of the trade. Let’s see where this goes.

There was plenty of momentum at the open bell. The channels offer a perspective on just how strong that momentum was. We could add other things to the analysis to determine whether to take the trade.

However, the channels alone would NOT have offered a trade opportunity where the orange range line is located.

Keltner Channels Example

Suppose other analysis could be performed with additional studies (volume, VWAP, fibonacci levels, other areas of support or resistance). Then perhaps a different choice would be made, BUT we are still within the O.R. and performing analysis with only candles and the Keltner Channels.

Keltner Example

How to Trade Keltner Channels

The first opportunity to take a trade came when the price bounced off the lower Keltner Channel Band and struggled through the middle Keltner Channel resistance. This was a clearly defined momentum run with a nice stop loss at the lower band. There are two ways to consider an exit with the Keltner channel bands. Exit when the price closes inside the channel bands or exit when the price closes below the middle channel band. While there are numerous ways to develop an exit strategy, we are focused here on using the candles and the channels.

Channels Example

Again, we are presented with the pattern to define the trade entry. Price bounces off the lower band and penetrates the middle Keltner channel. A candle close above the middle line is the confirmation for entry. The stop loss again is clearly defined by the lower channel band.

Why Keltner Channels?

The examples show that the Keltner channel study offers a trader an opportunity to enter a trade even after the ticker has begun to run, along with a clearly defined stop loss.

While I did not cover the exit strategy in detail, the Keltner channel study does offer some hard rule options for an exit. This Keltner study could be your desired momentum measurement combined with other indicators.

Keltner Indicators

ThinkorSwim

We need to modify the Thinkorswim Keltner channel study to indicate when our strategy is set up. We need to develop a scanner to identify stocks with these set-ups.

ThinkorSwim Keltner

These labels and the colors used for the thinkorswim study that I developed to go with the Keltner strategy discussed today. When the candle closes outside the outer Keltner channel band, a green label will appear in the screen’s upper right corner and say “Keltner POP.”

Then, when the candle crosses through the top of the outer band and closes inside the channel, you will see a pink label that says “Keltner FADE.” When the candle crosses below the Keltner lower band, you will see a red label that says “Keltner Failure.”

When the candle crosses through the lower band and closes inside the Keltner bands, you will see a “Keltner Recovery” label. You will not see any labels from this indicator at all other times.

If the candle passes through the channel’s center line, you will hear an alert and send a message to the thinkorswim message center.

When you open the ‘Edit Studies” tab in the thinkorswim platform, you may see a white circle with a black (?) inside it on the right side of a study. When you click on that circle, a hint should tell you about the study selected.

Studies
Scanner Template

The Stock Scanner Template has been coded to look for a candle crossing through the middle Keltner channel line (in the up or down direction) within 3 bars. This scanner is just the template. The price of stocks, float size, or other scanner criteria have not been defined.

Final Thoughts

Keltner channels can be great for finding entries and exits during a momentum move. Many times, we wait for a pullback. Chasing should be avoided at all costs. As a result, the Keltner channel may help you find an entry in a run.

Frequently Asked Questions

  • Here are the differences between Bollinger bands and Keltner channels:
  • Keltner channels show volatility using high & low prices
  • Bollinger bands use standard deviation
  • They both show important support and resistance levels

The most popular settings for Keltner Channels are 2 x ATR (10) for the upper and lower lines and EMA (20), which is the middle line.

Keltner Channels also uses an exponential moving average, which is more sensitive than the SMA used in Bollinger Bands.

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