Keltner Channel Trading Strategy (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.

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 formula calculates three lines: the middle line is typically a 20-period exponential moving average (EMA), while the upper and lower bands are derived by adding and subtracting the Average True Range (ATR) from the EMA.

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.

Further below in this article, we test different quantified rules for Keltner Bands.

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 strategy?

We did a search on the internet and we found very few quantified tests based on the Keltner Bands. We decided to perform our own:

Keltner Bands strategies (Backtest and historical performance):

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:

Keltner bands strategy

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).

Keltner Bands as momentum indicator:

Let’s flip some of the rules:

Trading Rules

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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.

How are Keltner Bands Calculated?

Keltner Bands are calculated based on the “typical price,” which is the high, low, and close divided by three. The upper and lower bands are then determined by adding and subtracting the Average True Range (ATR). Get insights into the formula and coding details in Amibroker.

How Can Keltner Bands be Used in Trading?

Explore different ways to use Keltner Bands in trading, such as mean reversion by buying when the price breaks below the bottom band or going long when the price breaks above the upper band. Understand that there is no one-size-fits-all approach.

How can traders interpret Keltner Bands signals effectively?

To interpret Keltner Bands signals effectively, traders can start by understanding that when the price touches or crosses the upper band, it may indicate overbought conditions, suggesting a potential sell signal. Conversely, when the price touches or crosses the lower band, it may indicate oversold conditions, suggesting a potential buy signal. Additionally, traders can look for confirmation from other technical indicators or price patterns to strengthen their analysis.

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 Bands be customized for specific trading styles or markets?

Yes, Keltner Bands can indeed be customized for specific trading styles or markets. Keltner Bands, like many technical indicators, offer flexibility for customization to suit different trading styles or markets. Traders can adjust parameters such as the length of the moving average, the multiplier for the average true range, or the type of price data used (such as closing prices or high/low prices). These adjustments allow traders to tailor Keltner Bands to better fit the characteristics of the asset being traded or the specific strategy being employed. For example, a day trader might use shorter-term settings for intraday trading, while a swing trader might opt for longer-term settings to capture broader market movements. Additionally, traders operating in highly volatile markets might choose wider bands to account for larger price fluctuations, while those in quieter markets might prefer narrower bands for more precise signals. Ultimately, customization enables traders to adapt Keltner Bands to their unique preferences and objectives, enhancing their effectiveness in making informed trading decisions.

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 Bands for trading?

When employing Keltner Bands for trading, traders typical look for entry opportunities when the price breaks above the upper band, indicating potential upward momentum. This breakout above the upper band suggests a bullish trend, prompting traders to consider entering a long position. Conversely, for exit points, traders may choose to exit their long positions when the price falls below the lower band. This breach below the lower band indicates potential weakness or a reversal in the bullish trend, prompting traders to consider closing their positions to avoid further losses or to reassess market conditions.

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

In adapting Keltner Bands settings to market volatility, traders typically increase the band width when volatility is high and reduce it when volatility is low. This adjustment allows for better alignment with the prevailing market conditions, enabling traders to capture price movements more effectively within the bands.

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

When trading with Keltner Bands, traders determine position size by considering factors such as risk tolerance, volatility, and the distance between the asset’s price and the bands.

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