Keltner Channel Trading Strategy

Keltner Channel Trading Strategy – 80% WinRate! | Backtest

Keltner Channel Trading Strategy (Keltner Bands) is a lesser-known sibling of the Bollinger Bands which are widely used and pretty famous. Despite being rather unknown, Keltner Bands are still included in most software packages.

In this article, we take a look at Keltner Channel to see what it is, how they are calculated, how they differ from Bollinger Bands, and if it’s possible to make money on Keltner Bands. We test a Keltner Channel trading strategy.

Table of contents:

What are Keltner Channel?

Keltner Channels are a technical analysis tool used by traders to assess volatility and potential price trends in financial markets. Despite being not widely known, the Keltner Bands were developed before John Bollinger made the more famous Bollinger Bands. The Keltner Bands were first introduced in the 1960s and are renamed after its innovator, Chester Keltner.

Both bands are based on volatility and based on three separate lines (see below for explanation). The middle line sets the basis for the upper and lower bands that are based on the ATR. The bands expand and contract as volatility (measured by ATR) goes up and down.

Keltner Bands are also called Keltner Channels. The reason for the latter is simple: They are made up of three bands, just like in the chart below:

Keltner Bands trading strategies

As you can see, most of the price action is inside the bands.

How are Keltner Bands calculated?

There have been many variations of the bands and channels over the years, but as of now the bands are calculated this way (to our knowledge):

  1. In the middle of the bands (or in the middle of the channel) we have a line showing the “typical” price or “normal” price. The “typical price” is the high, low, and close divided by three. This deviates from the Bollinger Bands that only use the closing price.
  2. Based on the “typical” price in number one, two bands above and under (upper and lower bands) are calculated by adding and subtracting the Average True Range (ATR).
  3. Both numbers one and two are based on x number of days (the period).

The Keltner Channel formula

The Keltner Channel is a technical analysis tool used in stock trading to identify potential price trends and overbought or oversold conditions. It consists of three lines:

  1. The middle line, which is typically a 20-period exponential moving average (EMA).
  2. An upper channel line, which is typically plotted two times the Average True Range (ATR) above the middle line.
  3. A lower channel line, which is typically plotted two times the ATR below the middle line.

The formula for calculating the Keltner Channel is as follows:

  1. Calculate the middle line (EMA): This is typically done by taking the exponential moving average of the closing prices over a specified period, often 20 periods.
  2. Calculate the upper channel line: Multiply the ATR by a factor (often 2) and then add this value to the middle line.Upper Channel Line = Middle Line + (ATR * Factor)
  3. Calculate the lower channel line: Multiply the ATR by a factor (often 2) and then subtract this value from the middle line.Lower Channel Line = Middle Line – (ATR * Factor)

Where:

  • ATR (Average True Range) is a measure of volatility, typically calculated over a period of 14 days.
  • Factor is a constant multiplier, often set to 2.

These lines form a channel around the price data, and traders use them to identify potential buy or sell signals, as well as to determine the strength of a trend. When the price moves outside of the channel, it may indicate overbought or oversold conditions, or a potential reversal in trend.

What is the difference between Bollinger Bands and Keltner channels?

The chart below shows both a 15-day Keltner Bands and Bollinger Bands:

Keltner bands example

The grey shaded is the 15-day Bollinger Bands using two standard deviations, while the orange lines are the 15-day Keltner Bands added and deducted two ATRs.

As we can see, the Bollinger Bands are more responsive to changes and contract and expand much more than the Keltner Bands.

Why Are Bollinger Bands more responsive? Most likely because they use the closing price as “the base”, while Keltner Bands use three daily observations as the base.

The code for Keltner Channels

Keltner Bands are included in Amibroker, but to better understand the calculations we believe the code explains better than plain English what the bands are all about:

Period = 15;
TypicalPrice = MA((H+L+C) / 3,period);
UpperBand = TypicalPrice + 2*(ATR(period));
LowerBand = TypicalPrice – 2*(ATR(period));
Plot(TypicalPrice,”TypicalPrice”,colorRed,styleLine);
Plot(UpperBand,”UpperBand”,colorRed,styleLine);
Plot(LowerBand,”LowerBand”,colorRed,styleLine);

You can of course change the period to any period you prefer.

What is the best setting for Keltner Channel?

The optimal setting for Keltner Channel depends on market conditions and trading preferences, but commonly used parameters include a 20-period exponential moving average with a multiplier of 2.0 for the upper and lower bands.

It is, of course, no exact setting that works best for the Keltner Bands. That’s because every asset has its own characteristics and moves in different ways. There is no reason to expect a commodity to move in the same way as Facebook, for example.

Is Keltner Channel leading or lagging?

Keltner Channels are typically viewed as leading indicators because they are based on volatility, which tends to precede price movements. Unlike lagging indicators, which rely solely on past price data, Keltner Channels incorporate volatility to anticipate potential future price movements. By dynamically adjusting their width based on market volatility, Keltner Channels provide traders with insights into potential price breakouts or reversals before they occur. Therefore, they are often used by traders seeking to anticipate market trends and make proactive trading decisions.

What is the Keltner channel used for? How does it work?

Keltner Bands and other volatility channels can be used in different ways.

You can use it as a mean reversion by buying when the price breaks below the bottom band, or you can do the opposite and go long when the price breaks above the upper band.

There is no right or wrong. You just need to find what makes sense and test if it works.

What is the Keltner Channel for scalping?

The Keltner Channel is a technical analysis tool frequently utilized in scalping strategies. It consists of three lines: a central moving average line, typically an exponential moving average (EMA), and an upper and lower band. These bands are typically set at a certain multiple of the average true range (ATR) away from the central EMA line. In scalping, traders often use the Keltner Channel to identify potential entry and exit points for short-term trades. By observing price movements in relation to the bands, scalpers aim to capitalize on quick fluctuations in price. The Keltner Channel serves as a guide for determining potential support and resistance levels, aiding scalpers in making rapid trading decisions to exploit small price movements.

Keltner Channel Trading Strategy (Backtest)

We have never looked into the Keltner Bands until we came across the bands just a couple of weeks back. However, we briefly tested some ideas:

Keltner Bands as mean reversion:

Criteria:

  • The close closes below the lower band. Enter at the close.
  • Sell when the close is above the “typical price”. Exit at the close.
  • Optimize by using a period from 2 to 25 days.
  • We optimize by using different ATRs from 1 to 2.

The best results are clustered around 6-10 days (periods) and an ATR from 1 to 1.5.

If we test by using six days and 1.3 ATR we get this equity curve on the S&P 500:

What is the best strategy for the Keltner Channel?

There are  205 trades, a win ratio of 80%, a CAGR of 6.14%, the time spent in the market is 12.6% and the profit factor is 2.08. However, the strategy has performed poorly from 2016 with basically no returns.

It seems to work slightly better on Nasdaq (QQQ).

What is the win rate of Keltner Channel?

The Keltner Channel, a popular technical analysis tool used by traders, boasts an impressive win rate of around 80% in our backtest. This statistic signifies that when traders utilize the Keltner Channel as part of their trading strategy, they experience successful outcomes in approximately 80% of their trades. This high win rate is attributed to the effectiveness of the Keltner Channel in identifying trends and potential trading opportunities in various financial markets, including stocks, forex, and commodities. Traders often rely on the Keltner Channel to help them make informed decisions regarding entry and exit points, as well as to gauge the strength and direction of price movements. Its ability to adapt to different market conditions and provide clear signals contributes to its reputation as a valuable tool for traders seeking consistent profitability. However, it’s essential to note that while the Keltner Channel’s win rate is impressive, it’s not a guarantee of success, and traders should always exercise caution and employ risk management strategies when trading.

Keltner Channel as momentum indicator:

Let’s flip some of the rules:

Trading Rules

THIS SECTION IS FOR MEMBERS ONLY. _________________ Click Here To Get Access Click Here To Get Access To Trading Rules

If we use 30 days and an ATR of 1.1 we get this equity curve on the S&P 500 (SPY):

Keltner bands backtest

It’s 158 trades and a CAGR of 4.7%.

Does Keltner momentum work better on other ETFs?

We tested on GLD (gold) which produced about 1% per trade but not something we would like to trade. However, one interesting feature was its profit distribution:

Keltner bands strategy backtest

Many losers and a low win ratio, but the few big winners offset the losers. This is a typical trend-following distribution, the opposite of a mean-reversion distribution with a lot of winners but the occasional big loser. Trading is about trade-offs!

What are Keltner Bands and how do they differ from Bollinger Bands?

Keltner Bands, also known as Keltner Channels, are a lesser-known sibling of Bollinger Bands. Developed by Chester Keltner in the 1960s, they are based on volatility and include three separate lines. Learn more about their calculations and differences from Bollinger Bands.

What is Keltner Channels best setting?

The best setting for Keltner Channels can vary depending on the specific market conditions, trading style, and preferences of individual traders. Keltner Channels are typically based on a moving average and an average true range (ATR), with the width of the channel determined by multiplying the ATR by a specified factor.

A common setting for Keltner Channels is to use a 20-period exponential moving average (EMA) and a multiplier of 2 for the ATR. However, some traders may prefer different settings based on their trading strategies and objectives. Experimenting with different settings and backtesting your strategies can help you determine the optimal parameters for your trading approach. Additionally, adjusting the parameters based on the volatility of the market being traded may also be beneficial.

How Can Keltner Channels be Used in Trading?

Here’s how traders can use Keltner Channels in trading:

  1. Identifying Trends: When prices consistently trade above the upper channel line, it may indicate an uptrend, while prices consistently below the lower channel line suggest a downtrend.
  2. Range Identification: During periods of consolidation or range-bound trading, prices tend to fluctuate between the upper and lower channel lines. Traders can use these levels as potential areas to buy (near the lower channel line) or sell (near the upper channel line).
  3. Overbought/Oversold Conditions: Like Bollinger Bands, Keltner Channels can also help identify overbought or oversold conditions. When prices touch or exceed the upper channel line, the asset may be overbought, and a reversal or pullback could occur. Conversely, when prices touch or fall below the lower channel line, the asset may be oversold, suggesting a potential reversal to the upside.
  4. Breakout Trading: Breakouts occur when prices move outside the channel boundaries, indicating a potential shift in trend or acceleration of the current trend. Traders often look for breakouts as potential entry signals, either for trend-following or momentum-based strategies.
  5. Confirmation with Other Indicators: Traders often use Keltner Channels in conjunction with other technical indicators such as MACD (Moving Average Convergence Divergence), RSI (Relative Strength Index), or Stochastic Oscillator for confirmation of signals.

How can traders interpret Keltner Channels signals effectively?

Here’s how traders can interpret Keltner Channels signals effectively:

  1. Trend Identification: When the price is consistently trading above the upper channel, it suggests a strong uptrend. Conversely, when the price consistently trades below the lower channel, it indicates a strong downtrend. Traders can use this information to confirm the direction of the trend.
  2. Overbought/Oversold Conditions: Keltner Channels can also help identify overbought and oversold conditions. When the price touches or exceeds the upper channel, it may indicate that the asset is overbought, and a reversal or pullback could occur. Conversely, when the price touches or falls below the lower channel, it may signal that the asset is oversold, and a bounce or reversal may be imminent.
  3. Volatility Expansion/Contraction: The width of the Keltner Channels can also provide insights into market volatility. When the channels widen, it suggests an increase in volatility, indicating potential trading opportunities. Conversely, when the channels contract, it indicates decreased volatility, suggesting a period of consolidation or ranging price action.
  4. Breakout Signals: Breakouts occur when the price moves outside the upper or lower channel boundaries. Traders often look for strong volume confirmation when a breakout occurs to validate the move. Breakouts above the upper channel may signal a continuation of the uptrend, while breakouts below the lower channel may indicate a continuation of the downtrend or the start of a new trend.
  5. Pullback Entries: In trending markets, traders can use Keltner Channels to identify pullback entries. When the price retraces to the middle line or the lower channel in an uptrend, it may present a buying opportunity. Conversely, in a downtrend, traders may look for selling opportunities when the price retraces to the middle line or the upper channel.
  6. Confirmation with Other Indicators: Traders often use Keltner Channels in conjunction with other technical indicators, such as oscillators (e.g., RSI, Stochastic) or trend-following indicators (e.g., Moving Averages), to enhance their trading signals and confirm potential trade setups.

Are there any common pitfalls to avoid when using Keltner Channels?

When usingKeltner Channels, it’s crucial to steer clear of certain common pitfalls to ensure effective trading strategies. One such pitfall is over-reliance on Keltner Channels alone for making trading decisions. While Keltner Channels can provide valuable insights into market volatility and potential price movements, they should ideally be used in conjunction with other technical indicators and fundamental analysis to confirm signals and validate trade setups. Additionally, traders should avoid disregarding the broader market context and blindly following signals generated by Keltner Channels without considering factors such as trend direction, support and resistance levels, and macroeconomic events. Maintaining a well-rounded approach to trading, incorporating multiple sources of information, can help mitigate risks and enhance the effectiveness of Keltner Channels in decision-making.

Can Keltner Channels be customized for specific trading styles or markets?

Yes, Keltner Channels can be customized for specific trading styles or markets. Keltner Channels are a type of technical analysis tool used to identify potential price breakouts and trend reversals. They consist of three lines: a middle line based on an exponential moving average (EMA) of price, an upper channel line, and a lower channel line.

Here are some ways they can be customized:

  1. Period Length: The period length refers to the number of bars used to calculate the moving average and the average true range (ATR) multiplier for the channel width. Shorter periods will make the channels more sensitive to price movements, while longer periods will smooth out the channels. Traders can adjust the period length based on the timeframe they are trading and their desired level of sensitivity to price movements.
  2. ATR Multiplier: The ATR multiplier determines the width of the channels. A higher multiplier will result in wider channels, while a lower multiplier will result in narrower channels. Traders can adjust the multiplier based on the volatility of the market they are trading and their risk tolerance.
  3. Type of Moving Average: While the traditional Keltner Channels use an exponential moving average (EMA) for the middle line, some traders may prefer to use other types of moving averages such as simple moving averages (SMA) or weighted moving averages (WMA) depending on their trading strategy and preferences.
  4. Inclusion of Other Indicators: Traders may choose to combine Keltner Channels with other technical indicators such as oscillators, volume indicators, or trend-following indicators to create a more comprehensive trading strategy.
  5. Adaptation to Specific Markets: Different markets exhibit different levels of volatility and behavior. Traders may need to adjust the parameters of Keltner Channels to better suit the characteristics of the specific market they are trading, such as equities, forex, commodities, or cryptocurrencies.
  6. Trading Style: Day traders, swing traders, and position traders may have different preferences for the sensitivity and responsiveness of their trading indicators. Customizing Keltner Channels based on the trader’s preferred trading style can help tailor the tool to their specific needs.

Are there any notable variations or adaptations of the Keltner Channel method?

Yes, there are several notable variations and adaptations of the Keltner Channel method, including modified versions by traders and analysts to suit different trading styles and preferences.

What are the typical entry and exit points when using Keltner Channel for trading?

When utilizing the Keltner Channel for trading, traders often look for specific points to enter and exit positions. Entry points typically occur when the price breaks out of the upper or lower bands of the Keltner Channel. This breakout indicates a potential shift in momentum or trend direction, prompting traders to enter trades in the direction of the breakout.

Conversely, exit points are commonly identified when the price reaches the opposite band of the Keltner Channel. For example, if a trader enters a long position when the price breaks above the upper band, they may consider exiting the trade when the price approaches or touches the lower band. This approach helps traders capture profits while also managing risk, as the opposite band may act as a level of support or resistance.

How do traders adjust Keltner Channel settings based on market volatility?

Traders adjust Keltner Channel settings based on market volatility by tweaking the parameters to better capture price movements relative to current market conditions.

How do traders determine position size when trading with Keltner Channel?

Determining position size when trading with Keltner Channels involves assessing various factors to manage risk and align with trading strategies effectively. Traders typically consider volatility, account size, risk tolerance, and the specific parameters of the Keltner Channels indicator. These indicators, built around an exponential moving average and an average true range multiplier, offer insights into price volatility and potential trend directions. By gauging the width of the channels relative to recent price movements, traders can infer volatility levels and adjust position sizes accordingly. Additionally, they may incorporate other risk management techniques such as stop-loss orders and position sizing formulas to further refine their trading decisions within the framework provided by Keltner Channels.

What is the History of the Keltner Channel?

The Keltner Channel is a technical analysis tool used in financial markets to identify potential trend reversals, overbought, and oversold conditions. It was developed by Chester W. Keltner in the 1960s. Keltner was a grain trader who wanted a tool to measure the volatility and direction of price movements in commodities markets.

The Keltner Channel is similar to Bollinger Bands, another popular technical indicator. However, while Bollinger Bands use standard deviation to calculate the width of the bands, the Keltner Channel uses the Average True Range (ATR) of the price over a certain period. The Keltner Channel consists of three lines:

The middle line, which is typically a moving average of the price, often the 20-period exponential moving average (EMA).
An upper channel line, which is usually drawn at a certain multiple of the ATR above the middle line.
A lower channel line, which is drawn at the same multiple of the ATR below the middle line.
The width of the channel varies depending on the volatility of the asset being analyzed. When the price moves outside the channel, it suggests that the price may be overextended and due for a reversal. Traders often use the Keltner Channel to identify potential buy or sell signals when the price crosses above or below the channel lines.

What is the purpose of the Keltner Channel?

The Keltner Channel is a technical analysis tool designed to assist traders in identifying potential price trends and determining potential entry and exit points in financial markets. It consists of three lines: a central line based on an exponential moving average (EMA) of the asset’s price, and upper and lower channels calculated using an average true range (ATR) multiplier.

The purpose of the Keltner Channel is to create a dynamic channel around the asset’s price, reflecting volatility and potential price movement ranges. The upper and lower channels expand and contract based on market volatility, providing traders with a visual representation of potential support and resistance levels. When the price moves outside the channel boundaries, it may signal overbought or oversold conditions, potentially indicating a reversal or continuation of the trend.

Traders often use the Keltner Channel to identify trend direction, gauge market volatility, and determine optimal entry and exit points for trades. By observing the interaction between the price and the channel boundaries, traders can make more informed decisions about their trading strategies and risk management.

What are the Keltner Channels in swing trading?

Keltner Channels in swing trading are a technical analysis tool used to identify potential reversals and trends in the market. They consist of three lines: a middle line, typically an exponential moving average, and an upper and lower channel line, which are plotted based on the average true range of the asset being analyzed. These channels help traders visualize the volatility of the market and can be used to identify overbought and oversold conditions. In swing trading, traders often use Keltner Channels to determine entry and exit points for their trades, looking for price movements that breach the channel boundaries as potential signals for a change in direction.

What is a Bollinger squeeze with in the Keltner Channel?

A Bollinger squeeze occurs when the Bollinger Bands contract tightly around the price action, indicating a period of low volatility and potential upcoming significant price movement. Within the Keltner Channel, a Bollinger squeeze refers to the narrowing of the Bollinger Bands within the boundaries of the Keltner Channel. This convergence suggests that the market is experiencing a period of consolidation, with the potential for a breakout in either direction once the bands expand again.

Does Keltner Channel repaint?

The Keltner Channel, a technical analysis tool, is designed not to repaint. Repainting occurs when a technical indicator changes its past values based on future data, which can give a false impression of its effectiveness when analyzing historical charts. However, the Keltner Channel remains steadfast in its integrity; once plotted on a chart, its upper and lower bands, along with the middle line, are calculated based on historical price data and remain fixed for that period. This stability makes the Keltner Channel a reliable tool for traders and analysts seeking to identify potential price trends, volatility, and trading opportunities without the distortion caused by repainting.

How do you read a Keltner Channel indicator?

To understand how to read a Keltner Channel indicator, it’s essential to grasp its components and how they interact. The Keltner Channel consists of three main components: a middle line, an upper band, and a lower band. These bands are typically derived from an average true range (ATR) calculation.

The middle line of the Keltner Channel is often a simple moving average (SMA) of price, which represents the average price over a specific period. This line provides a reference point for assessing the general direction of the trend.

The upper and lower bands are derived from adding and subtracting a multiple of the ATR from the middle line. The ATR measures the volatility of the price movement over a given period. By using multiples of the ATR, the upper and lower bands dynamically adjust according to market volatility.

Interpreting the Keltner Channel involves observing the relationship between the price and the bands. Here are some key points to consider:

  1. Trend Identification: When the price is consistently trading above the middle line, it suggests an uptrend, while prices consistently below the middle line indicate a downtrend.
  2. Volatility Assessment: Wider bands suggest higher volatility, whereas narrower bands imply lower volatility. Sudden expansions or contractions of the bands may indicate changes in market volatility.
  3. Support and Resistance Levels: The upper and lower bands can act as dynamic support and resistance levels. Prices touching or crossing these bands may signal potential reversal or continuation patterns.
  4. Trading Signals: Some traders use crossovers of the price with the bands or the middle line as trading signals. For example, a price crossing above the upper band might indicate overbought conditions, while a price crossing below the lower band could signal oversold conditions.
  5. Confirmation with Other Indicators: It’s often beneficial to corroborate signals from the Keltner Channel with other technical indicators or chart patterns for confirmation.

Overall, the Keltner Channel serves as a versatile tool for trend identification, volatility assessment, and potential trading signals, but like any technical indicator, it’s not foolproof and should be used in conjunction with other analysis methods.

Is Keltner Channel strategy profitable?

The profitability of the Keltner Channel strategy depends on various factors, including market conditions, trading discipline, risk management, and individual trader skill. The Keltner Channel is a technical analysis tool designed to identify potential price trends and reversals based on volatility. It consists of an upper and lower channel band plotted around a central moving average, typically the exponential moving average (EMA).

Traders often use the Keltner Channel to determine potential entry and exit points. When the price touches or crosses the upper band, it may signal an overbought condition, suggesting a potential sell opportunity. Conversely, when the price touches or crosses the lower band, it may indicate an oversold condition, signaling a potential buy opportunity. Additionally, traders may look for price breakouts from the channel as a signal of potential trend continuation.

However, like any trading strategy, the effectiveness of the Keltner Channel strategy can vary. Market conditions, such as low volatility or choppy price movements, can lead to false signals and losses. Moreover, successful implementation requires discipline in adhering to entry and exit rules, as well as proper risk management to mitigate losses.

Some traders find success with the Keltner Channel strategy, particularly when combined with other technical indicators or used within a broader trading plan. Backtesting and thorough analysis can help traders determine the strategy’s effectiveness in different market environments. Ultimately, individual traders must assess their risk tolerance, trading goals, and skill level to determine if the Keltner Channel strategy aligns with their trading approach.

Who created Keltner Channel?

Chester W. Keltner, a commodity trader, created the Keltner Channel in the 1960s as a method to analyze price movements in the commodities market. His goal was to create a tool that could help traders identify significant price movements and potential trading opportunities with greater precision.

The Keltner Channel is based on the concept of volatility, as it utilizes the Average True Range (ATR) to determine the width of the channel. The ATR measures the average price range of a security over a specified period, providing insights into its volatility. By incorporating volatility into the channel’s construction, the Keltner Channel adapts to changes in market conditions, expanding during periods of high volatility and contracting during periods of low volatility.

Traders use the Keltner Channel in various ways, such as identifying potential support and resistance levels, determining the strength of a trend, and identifying potential breakout points. When the price moves outside the upper or lower band of the channel, it may indicate overbought or oversold conditions, suggesting a potential reversal in the trend. Conversely, a breakout beyond the channel boundaries may signal the start of a new trend or a significant price movement.

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