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Chapter 3: Keltner Channels

Keltner Channels were originally conceived by Chester Ketlner in the 1960s; however, Linda Raschke, a successful trader, updated and reintroduced this technical indicator in the 1980s. The most common formula is predicated on Average True Range (ATR), which is evaluated over 10-periods. Following this calculation, the value of ATR is doubled and a 20-period exponential moving average is added to compute the positive band, and subtracted to compute the negative band. The middle line is an exponential moving average of the underlying price, which is usually 20-periods; however, this is manually adjustable.

The Keltner Channel Formula:

Keltner Channel Middle Line = EMA

Keltner Channel Upper Band = EMA+(ATR x Multiplier)

Keltner Channel Lower Band = EMA−(ATR x Multiplier)

where:

EMA = Exponential moving average (typically over 20 periods)

ATR = Average True Range (typically over 10 or 20 periods)

Keltner channels resemble trading bands; however, their implications differ from STARC bands . Keltner bands are usually much tighter and a buy signal is produced when prices close above the upper band. This is because a close above the upper band indicates a possible upwards breakout in volatility. A sell signal is given when prices close below the lower band. ​A close below the lower band is symbolic of a possible downwards breakout. The bands will expand as volatility expands, and the bands will contract while volatility diminishes. Price movement will generally trend within the bands, so a close outside of their range signals a potential volatility breakout. Price movement outside the Keltner Channels may also signal an advancement of the immediate trend, and sometimes a potential change in trend. For example, if prices are trending at the lower band for several sessions and surge of buying pressure commences causing prices to close above the upper band, this may signal a change in the immediate trend from bearish to bullish. Price movement tends to fluctuate between the upper and lower band, and in this respect, the upper band constitutes support, while the lower band constitutes resistance. Contingent on the multiplier of ATR, the Keltner Channel will be wider or narrower. When the ATR multiplier is of lesser value, the bands will become narrower, and price movement will reach or transcend the bands more frequently. When the ATR multiplier is of greater value, a larger channel will be produced and prices will test the bands infrequently. When prices are persistently testing the upper band but not the lower band, once the lower band is finally tested, it may be indicative of an uptrend losing momentum. When prices are persistently testing the lower band but not the upper band, once the upper band is finally tested, it may be indicative of a downtrend losing momentum. 

Figure 1.1 Keltner Channels

Keltner Channels

(NYSE: BABA)

Figure 1.2 Keltner Channels Buy/Sell

How to Use Keltner Channels

(NYSE: LOW)

Figure 1.3 Keltner Channels Buy/Sell

What are Keltner Channels

(NYSE: MCD)

Figure 1.4 Keltner Channels Buy/Sell

How to Use Keltner Channels

(NASDAQ: TSLA)

Practical Use – Straight Talk

A trading system predicated on Keltner Channels is likely to incorporate a low win-rate. Of course, a low win-rate doesn’t always catalyze a net-loss so long as the average winner considerably exceeds the average loser. A Keltner Channel system looks to exploit strong buying/selling pressure. Prices may close outside the bands when their narrow; however, a volatility breakout won’t always follow. The aforementioned sequence describes a false signal. False signals occur frequently with the indicator. If you cut erroneous positions short and maximize winners: a Keltner Channel trading system can work fine. Using the 200 SMA, or a moving average of similar length, as a position filter diminishes the probability of closing a position for a loss.

Backtesting a Keltner Channel Trading System

Entry Criteria (Long)

  1. SMA 50 > SMA 200
  2. Prices cross over and close above upper Keltner band (Long)

Exit Criteria (Long)

  1. Prices cross under and close below the mid-point (EMA)

Entry Criteria (Short)

  1. SMA 50 < SMA 200
  2. Prices cross under and close below the lower Keltner Band (Short)

Exit Criteria (Short)

  1. Prices cross over and close above the mid-point (EMA)

Figure 1.5 Keltner Channel Backtest – All Historical Price Data

Keltner Channels Backtest

Figure 1.6 Keltner Channel Backtest – Out-of-Sample Price Data

Backtest

Figure 1.7 Keltner Channel Backtest – In-Sample Price Data

Backtesting

Figure 1.6 Keltner Channel Backtest – Previous 5 Years of Price Data

What is Backtesting?

Our Keltner Channel trading system incorporated a low win-rate, but achieved a respectable net-profit.

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