The
Keltner Channel (KC) indicator was developed in the middle of the last century
and has since been actively used in technical analysis. The tool belongs to
channel indicators and allows you to build the channel of price movement relative
to the moving average, but unlike the Bollinger Bands (BB) this indicator
practically does not increase the channel corridor following the price, allowing
the markers to break out of the defined boundaries and demonstrate a strong closing
trend.
The
channel indicator consists of three lines: two of them limit the price
corridor, and the centerline is the exponential moving average.
Due to the fact that the channel width weekly correlates with a trend
change, the KC has no use when trading flat, simply because it is not able to identify
the market uncertainty.
Despite
the fact that the Keltner Channel was created more than half a century ago, it is
still relevant. If the trader correctly decodes its signals, he or she will be
able to find the right time to enter the market.
Channel strategies, in particular those with the KC involved, are based on
an understanding of the psychological part of the market. It has been
statistically proven that most of the time, namely about 80% of the trading
period, prices move within the channel, periodically approaching its boundaries,
but eventually returning to the center (the so-called point of equilibrium). Prices
can break through the channel boundaries, adapting to market conditions, and
this is what dozens of channel strategies are based on.
Many
traders use only the BB to develop a channel strategy but it is very difficult
to get a clear picture of what is happening in the market with this tool alone.
The problem is that when a trend forms, the boundaries of the BB channel expand
along with the price, and the trader will not be able to clearly determine the
breakout level and subsequent correction. This issue can be solved by using the
Keltner Channel.
To
illustrate how useful the Keltner Channel can be, we suggest you consider a
basic strategy that also uses the RSI (Relative Strength Index).
So,
we need the following to proceed:
Such
a model of market behavior is suitable for trading any popular currency pair.
It is recommended to use a 30-minute timeframe.
The conditions needed for going long:
If
there is a breakout of the channel boundaries, this may indicate rapid price movement.
However, it will not last long, and the RSI only confirms the transient nature
of the situation, so the trader needs to find the right moment. It is important
to open a position exactly at the moment when the channel breakout starts. If
you did not manage to do this, the next candle will become pointless. However,
if you did find the right moment, set a stop loss at 10 points. Your profit
should not exceed 20 points. Once a reversal candle occurs, close the trade.
The conditions needed for going short:
If
you follow a careful strategy of trading the market, you should close the trade
once a reversal candle begins to form. However, more experienced traders prefer
to watch how the situation unfolds for a while. For example, the reversal
candle turns out to be too small quite often, and after it, the price again
moves in the direction the trader needs. Moreover, a reversal candle can become
an indicator of the primary trend. In this case, the position should be closed
only when the body of the reversal candlestick has reached one third of the
last candle of the main movement. If after the candlestick is closed, its body
turns out to be smaller, it is quite possible that the price will continue to
move and the trader will be able to earn more.
This
indicator is effectively used for intraday trading, but in this case you should
use small timeframes, from M1 to H1. To better understand how to trade with the
indicator, we suggest considering two different situations:
1. Breaking through.
If
there is a certain price movement in the financial market, no matter upward or
downward one, you can follow a strategy based on breaking through the
boundaries by using the KC indicator. As the market gains momentum, the price leaves
the sideways range and, accordingly, breaks out of the channel boundaries.
A
significant signal for entering the market is a very rapid rise in price that goes
above the sideways range while simultaneously breaking through the trading
channel. As soon as a candlestick closed above the upper line of the KC
indicator, you can open a buy position, choosing the local low as a Stop Loss.
Your Profit in this case should be equal to the Stop value multiplied by 3.
If
the price leaves sideways range and simultaneously crosses the lower boundary
of the channel, it is a signal to sell your asset. A sell position opens
immediately after the candlestick is formed. As for your profit target, follow
the same guidelines as you would for a buy order.
2. Bouncing back
from the centerline.
This
behavioral model is relevant if a directional trend is formed, but the price is
correcting in the range of the centerline. In this case, you can open both buy
and sell positions. However, you need to trade only in the direction of the
current trend.
A
rebound from the upper boundary in the case of an uptrend is a signal to buy. The
price will correct itself and form a local low near the centerline, and then
should turn upward in the direction of the trend. Immediately after the upward
reversal, you need to open a buy position, and set a Stop at the already formed
local low. Your Profit in this case will be equal to the Stop value multiplied
by 2.
The
price bouncing back from the lower boundary of the channel when a downtrend is being
formed is a signal to sell. Once it reaches the centerline, a local high will
be formed, after which the price will go down. As soon as a rebound occurs, you
can open a sell position, and use the local high as a Stop. Your Profit will
also be equal to the Stop value multiplied by 2.
This
is not a standard channel indicator but its modified version based on the
traditional KC and Bollinger Bands. As a result, the tool does not draw the
channel extremes but visualizes the direction of the market trend after the
price reversal and movement to its average value. The lines can appear both
above and below the asset price, green means an uptrend, and orange a downtrend
(once it touches the boundary of the virtual channel, the color of the line
changes).
The
nuances of trading with the Keltner Stops Channel:
Remember that the indicator gives quite rare signals when considering the
set timeframe.