Learn three proven techniques you can use every day to trade with the Keltner trading strategy. The Keltner channel system can improve your profitability because it adapts to the ever-changing Forex market conditions.
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In this detailed step-by-step trading guide, you’ll learn about the Keltner channel indicator. We believe it can help you become a profitable trader. First, you'll learn some background information about the Keltner Channel to make more informed trading decisions.
This amazing indicator works best when used in conjunction with other technical indicators and/or chart analysis.
Now let's learn how to trade with Keltner channels indicator and how it can help you trade in different market conditions.
How to Trade With Keltner Channels
Keltner Channel is a technical indicator that belongs in the envelope indicators family. An envelope indicator, when plotted on a price chart, will display an upper and lower band. This creates a dynamic channel that contains the price range inside the two bounds.
Note* The price has the tendency to trade outside the Keltner channel boundaries. This often happens in the presence of a strong trend.
The Keltner Channel is a volatility-based indicator comprised of a simple exponential moving average and around it we have a lower band and upper band that is based on a setting that you use.
Our preferred Keltner channel parameters is to use a 20-period for the middle exponential MA with a multiplier of 2 for the extreme bands.
Keltner channel will assist you objectively measure the market volatility, assess the current trend, spot potential breakout trades, trade pullbacks and trend reversals. You can also use scalping techniques with keltner channel if you want to be in and out of a trade very fast.
Basically, the channel created provides an envelope for the price and they are very similar with the Bollinger Bands indicator. The difference between the two is that Keltner Channels are based on ATR (Average True Range) while Bollinger Bands are based on a standard deviation.
If you want to get more technical and understand the math behind this volatility indicator see the formulas below:
- Middle Band = 20-Period Exponential Moving Average Value
- Upper Envelope= 20-Period Exponential Moving Average Value + Multiplied Value of Average True Range (ATR)
- Lower Envelope = 20-Period Exponential Moving Average Value + Multiplied Value of Average True Range (ATR)
How to correctly interpret the Keltner volatility indicator.
During the time periods when the price kind of hugs the upper envelope and the upper band also points upwards, this is a signal of a strong bullish trend. In other words the price continuously crawl along the upper band.
Note #2: The same is true in reverse, in which case the volatility indicator signals a bearish trend.
When the Keltner bands are flat and moves horizontally, this trade signals the presence of a ranging market. In this case, the price tends to bounce between the upper and lower envelope without showing any clear directional bias.
Another practical trading application derived from the Keltner channel indicator is the ability to measure retracements. Keltner channel indicator is a good source of information when it comes to pinpointing the end of a pullback.
In the presence of a strong upward or downward trend, pullbacks tends to stall near the middle 20-period EMA.
Now, before we go any further, we always recommend taking a piece of paper and a pen and note down the rules of this scalping strategy.
For this article, we’re going to look at the buy side.
Keltner Channel System
The Forex market has a natural rhythm that goes from a trending market to consolidation and vice versa. However, you also have to deal with different types of volatility that changes constantly. That’s where the Keltner Channel system can help you be a more proficient trader.
Keltner Channel indicator is a really great little tool, but it tends to perform better when used in combination with other technical indicators.
Moving forward, we’re going to explore how you can combine the Keltner indicator with other tools and at the same time to suit the market environment you’re in.
We’re going to explore three typical examples where you can use the Keltner trading strategy.
Trading Breakouts with Keltner Channel
When it comes to breakout trading, Keltner Channel is a very powerful indicator. The keltner channel breakout system works best when volatility rises. However, the Keltner indicator measures not just the volatility, but it can also show anomalies in the price behavior.
Since Keltner channel indicator is lagging in nature, we can use a secondary tool like the ADX indicator to give us more confluence. These two indicators can help us catch explosive breakouts.
With the ADX we measure the strength of the breakout. Generally, and ADX reading above the 20 level is considered to be the beginning of a bullish/bearish trend. Any reading below 20 signals a period of consolidation.
The ADX needs to continue to rise to suggest that the trend is strong. When the Keltner Channel is used in combination with the ADX indicator, you can trade breakouts with objectivity.
Trigger conditions for buying breakouts:
- Keltner Channel bands need to turn flat.
- Price need to break above the upper band.
- ADX needs to cross above the 20 level.
Follow the above trading rules if you want to avoid most of the false breakouts.
Trading Ranging Markets with Keltner Channel
It is said that the number one account killer in the market is a ranging market. Consolidations are very difficult to trade. However, you can take advantage of the difference in the way Keltner channel system can be used in combination with other technical indicators.
The price won’t really touch the bands when it bounces between the upper and lower envelopes. When we’re in a ranging market, you’ll often see that the price will fail to touch the bands. The majority of the time the price will hug the middle band.
This anomaly in price behavior requires us to use a secondary technical indicator to find profitable trades.
Since the Forex market spends most of its time in consolidation, around 70% of the time, it’s mandatory to have a range trading strategy to survive in this market.
For range trading we like to use Keltner Channel bands in combination with a 2-period RSI indicator. We tweaked the RSI settings so we can better identify tops and bottoms within a trading range.
Note #3: For this Keltner trading strategy we use the 90-10 levels of overbought and oversold readings.
Here are some rules that can guide you to make the best trading decisions:
- Keltner envelopes need to turn flat, to signal a consolidation.
- Price needs to break below the middle band.
- A buy order is triggered once the 2-period RSI goes below 10 indicating oversold conditions.
- The protective stop loss can be hidden on the other side of the Keltner band.
- For the long side take profit when the RSI reaches the 90 level.
Trading Pullbacks with Keltner Channel
Trading pullbacks successfully can only be done in the presence of a strong trend. Using the Keltner channel indicator we can study how the price behaves around the upper and lower envelopes to gauge the strength of the trend.
As you already learned when the price hugs one of the two bands and crawls along the band, we have a case for a strong trending market.
In the chart below we’ve highlighted small retracements while the price hugs the upper Keltner band. Notice that the price retrace to the area around the 20-EMA. It won’t give you an exact price, but a price zone from where the price can potentially bounce and the bullish trend can resume.
This remains a good way to measure pullbacks in price. Successful trading doesn’t require catching the exact turning point.
For a better timing of our trades we can use the Stochastic RSI indicator in combination with the Keltner indicator for more confluence.
The trade trigger is simply to follow with this Keltner Channel pullback strategy. Pull the trigger when the price retraces to the middle band and the stochastic indicator develops a crossover from an oversold territory.
Conclusion – Keltner Channel System
Knowing what type of market environment you’re in, it can help you to decide what technical tools to use. Designing a trading strategy to suit all types of market environment requires a lot of work and back testing. With all honesty that’s very hard to accomplish and that’s the reason why we encourage you to learn how to trade with Keltner channels in combination with other tools.
Once you understand the power of Keltner channels and how to properly combine it with other technical indicators a new realm of trading opportunities will emerge. This amazing indicator comes with most trading platforms, but even if you can’t find it in the indicator library, you can still opt to use a third-party developed Keltner channel indicator.
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