Linda Bradford Raschke introduced the newer version of Keltner Channels in the s. This particular technique has been advocated by Kerry Lovvorn of SpikeTrade. This is where I would lock up, as I would be forced to make a decision. ALTR experienced a high volume gap up on May 29th.
Trends often start with strong moves in one direction or another. A surge above the upper channel line shows extraordinary strength, while a plunge below the lower channel line shows extraordinary weakness. Such strong moves can signal the end of one trend and the beginning of another. With an exponential moving average as its foundation, Keltner Channels are a trend following indicator.
As with moving averages and trend following indicators, Keltner Channels lag price action. The direction of the moving average dictates the direction of the channel.
In general, a downtrend is present when the channel moves lower, while an uptrend exists when the channel moves higher. The trend is flat when the channel moves sideways. A channel upturn and break above the upper trendline can signal the start of an uptrend.
A channel downturn and break below the lower trendline can signal the start a downtrend. Sometimes a strong trend does not take hold after a channel breakout and prices oscillate between the channel lines.
Such trading ranges are marked by a relatively flat moving average. The channel boundaries can then be used to identify overbought and oversold levels for trading purposes. There are two differences between Keltner Channels and Bollinger Bands. Many consider this a plus because it creates a more constant width. This makes Keltner Channels well suited for trend following and trend identification.
Second, Keltner Channels also use an exponential moving average, which is more sensitive than the simple moving average used in Bollinger Bands. Notice how the Keltner Channels are smoother than the Bollinger Bands. The chart below shows Archer Daniels Midland ADM starting an uptrend as the Keltner Channels turn up and the stock surges above the upper channel line.
ADM was in a clear downtrend in April-May as prices continued to pierce the lower channel. With a strong thrust up in June, prices exceeded the upper channel and the channel turned up to start a new uptrend. Notice that prices held above the lower channel on dips in early and late July. Even with a new uptrend established, it is often prudent to wait for a pullback or better entry point to improve the reward-to-risk ratio.
Momentum oscillators or other indicators can then be employed to define oversold readings. This chart shows StochRSI , one of the more sensitive momentum oscillators, dipping below. The subsequent crosses back above. The second chart shows Nvidia NVDA starting a downtrend with a sharp decline below the lower channel line. After this initial break, the stock met resistance near the day EMA middle line from mid-May until early August. The inability to even come close to the upper channel line showed strong downside pressure.
A period Commodity Channel Index CCI is shown as the momentum oscillator to identify short-term overbought conditions. A move above is considered overbought.
A subsequent move back below signals a resumption of the downtrend. This signal worked well until September. These failed signals indicated a possible trend change that was subsequently confirmed with a break above the upper channel line. Once a trading range or flat trading environment has been identified, traders can use the Keltner Channels to identify overbought and oversold levels.
The chart below shows IBM fluctuating between support in the area and resistance in the area from February to late September. The indicator window shows ADX black line confirming a weak trend. Low and falling ADX shows a weak trend. High and rising ADX shows a strong trend. ADX was below 40 the entire time and below 30 most of the time.
This reflects the absence of a trend. Armed with the prospects of a weak trend and trading range, traders can use Keltner Channels to anticipate reversals. In addition, notice that the channel lines often coincide with chart support and resistance. IBM dipped below the lower channel line three times from late May until late August. These dips provided low-risk entry points.
The stock did not manage to reach the upper channel line, but did get close as it reversed in the resistance zone. The Disney chart shows a similar situation. Keltner Channels are a trend following indicator designed to identify the underlying trend.
Trend identification is more than half the battle. The trend can be up, down or flat. Chester Keltner's formula and yet the indicator is still called Keltner Channels, but I would rather dive into the charts of comparing the Keltner Bands to Bollinger Bands.
Again, if you are looking for more technical articles on the two indicators, there are tons of posts on the web. I figured I would just stick to the comparison and leave the number crunching up to the mathematicians. With that said, let's dive into our first working example. Just to be clear we are using the default settings for both the Keltner Channels and Bollinger Bands found in most trading platforms, which is 20 periods. In the below chart example, we are reviewing a 5-minute chart of Ford with the default Keltner Channel settings of 20, 1 and the default settings for the Bollinger Bands.
You will notice on first glance at the chart that the channel is much tighter on the Keltner Channel. In this particular example, it was much clearer to me using the Keltner Channel that Ford was done once it hit its peak. If you zoom in on the example, you can see that there were two green bars and one red bar that were completely outside of the envelopes. Once the second candle closed below the low of the preceding red candlestick and inside of the envelopes, Ford was done.
Now, if you look at the exact same chart, but with the Bollinger Bands, the action was neatly inside of the envelopes, so as a trader you have a tougher time identifying when a stock is going to breakdown.
If you are day trading with the Keltner Channel, having the ability to quickly notice when a trend can be changing is huge. Therefore, in the example of riding the trend and knowing exactly when to get off the bus, I'm going to say Keltner 1, Bollinger Bands 0. For those of you wondering what is the difference between this example and riding the trend, it really comes down to the impulsiveness of the move.
As you can see in the above chart, the price action for the most part stayed completely outside of the Keltner Channel. In our first example, the price movement wasn't as extreme. The question comes down to which indicator would have me in sooner and allow me to ride the impulsive move higher? Once the move started, I would have to say that both the Keltner Channels and Bollinger Bands did a great job allowing the trend to develop.
Due to the early entry on the run up, I have to give round 2 to the Keltner Channels. Just a side note, assuming you are day trading, then the major gap down the next day would not apply because you would have closed your position. I spent 20 months chasing these late day bloomers before finally realizing this wasn't my calling. In the below example, we will dig into whether the Keltner Channels or Bollinger Bands can better detect when a stock is beginning to trend late in the day.
There was a swing low put in around 1: This is where I would lock up, as I would be forced to make a decision. The volume of course would be light as we were in the early afternoon, yet there is a new low.
Well, the Keltner Channels provides us a nice head start on the move as the candlestick closes completely outside of the Keltner Channel. Now as we look over at the Bollinger Band example, the stock was still nicely sitting inside of the bands, albeit riding the bands.
For this example, I have to go with the Keltner Channel, because I will always go with outside of the bands versus riding the bands in terms of strength of trend. The morning reversal is another powerful day trading pattern, as stocks will experience sharp snap back moves. ALTR experienced a high volume gap up on May 29th.
As I was reviewing the Keltner Channel, I realized the candlesticks were well beyond the upper channel.