Keltner Channel Strategy

The Keltner Channel is a popular technical indicator found on most charting software programs. Chester Keltner, who was a grain trader in Chicago, first described the indicator in his 1960 book "How To Make Money in Commodities".

He described the center line of this trend-following indicator as a 10 day simple moving average of 'typical price'. Typical price was calculated adding a price bar's high, low and close and then dividing by three ==> (H + L + C) / 3.

The upper and lower channel lines were drawn a certain distance (+/-) from the center line. The distance was determined by calculating a 10 day simple moving average of price's range (high - low).

So basically, Keltner Channels are a volatility based envelope some what similar to Bollinger Bands, except they use the average true range of price to determine distance from the center line.

The Keltner Channels you'll see in the charts below use a 20 period exponential moving average of typical price and use a multiplier of 1.5 times ATR for the distance of the bands from the center line.


COMPONENTS

5 minute chart

Keltner Channel (setting: 20 - 1.5)

MACD Histogram (setting: 3 - 9 - 15)

KELTNER CHANNEL STRATEGY SIGNALS

This strategy attempts to use the channel to indicate to the trader when there is sufficient momentum in a stock or ETF (such as QQQQ below) to trade a pullback. Once there is enough momentum to warrant a trade, the MACD Histogram is used to trigger a trade in the direction of the immediate trend.

Again, not a complete day trading system until you add your exit strategy and trading money management.

Two possible exit strategies are profit objectives and trailing stops.

If you don't know where to place your initial Stop, try getting some ideas from my Stock Day Trading System page.

Areas of price support and resistance generally work well for initial stops. Of course, their disadvantage is that everyone knows where they're at.


Buy Setup: Two consecutive price bars close above channel

Buy Trigger: MACD Histogram is rising (at bar close)

Short Setup: Two consecutive price bars close below channel

Short Trigger: MACD Histogram is falling (at bar close)


EXAMPLE 1

Keltner Channel on 10 minute chart of QQQQ

You have to use some trading sense when using entries like above.

You'll notice on the chart above at around 12:20pm there is another signal to short according to the rules, but price had just made a new high. So, you'd have four options at that point:

1) Take the short as usual.

2) Take the short with a tighter stop.

3) Take the short with a plan to 'stop & reverse' if the stop is hit.

4) Don't take the trade.

In addition to a new high, price had just broken a trendline (not drawn on chart), and the MACD Histogram had a double divergence.

One could make a case for a long entry here instead of a short entry using the histogram for divergence, as in the Divergence Trading Strategy.

You can see from this example, why markets do what they do. Different traders can be looking at the same exact chart and get completely opposite ideas as to what price might do next.

EXAMPLE 2

Using MACD and Keltner Channel together