The Keltner Channels or Keltner Bands as they are sometimes referred to, is a technical indicator named after Chester W. Keltner. The bands are two lines plotted above and below a 10-day simple moving average(SMA) of the typical price. The typical price is an average of the high, low and close. So the SMA is the average of 10 day’s worth of the typical prices.
Typical Price = Sum of High+Low+Close then divided by 3.
Here is what the Keltner Channels look like on a chart:
There are different strategies in using the Keltner Channels to your trading advantage. The easiest and most effective method is to buy on the breaks of the channels. If your looking to buy and ride the bullish wave its good to purchase once the closing price closes above the upper band. Vice versa, if you’re looking to short a good buy is once the closing price closes below the second band. Here is an example:
Now, as you can see looking at the chart above trading strictly the Keltner Channels can lead to a lot of great profitable opportunities but it can also lead to a lot of false signals.
I personally never trade the Keltner Channels on their own. It's just not accurate enough for me. However, one of the best indicators that you can combine with the Keltner Channels is our best friend Money Flow Index. Check out the same chart that I showed above with the MFI added and see how it guides us to our Buy's and Sell's.
Here is a breakdown:
DISCLAIMER: MFI overbought territory is 80 MFI oversold territory is 20
A: Now, we missed out on some Puts on the way down to our Buy here at A. The reason for this is because our MFI was oversold. We don't want to enter into Puts when our MFI is so low. As MFI increases so will the price. So we wait and find our first entry at A. Now we decide to buy Calls here.
B: We ride the MFI to overbought territories but then use the Keltner Channels to help us decide when to sell. Remember, we will sell once the candle closes down from the "cloud" as shown here at point B.
C: Our MFI is back to being oversold and lucky for us our price is trading just under the bottom Keltner Channel. We decide to enter calls again.
D: Now we have used the Keltner Channels to help us decide when to exit our trade. As shown in D here our price ran up above the top channel and we let it ride a bit until we got a candle close under the cloud breaking. Now, we may have been shaken out on those three red candles a few candles back and if we would have that would be okay and still a successful and profitable trade.
We see a lot of "Dead zone" as I like to refer to it. Its trading inside the Keltner Channels but really no breakouts. Plus on top of this our MFI isn't getting to the oversold/overbought territories we need.
E: Here we find a great opportunity to purchase Puts. Buying Puts here is great because our MFI is very high and our price has shown a nice red candle above the top Keltner Channel meaning we could have a lot of room to fall. In this case we get lucky and do have a lot of room to fall.
Remember, just because the candle closes up into the channel or out of the channel doesn't determine when we take profits. We want to ride the MFI out first and once the MFI has done it's thing then we'll use the Keltner Channels to help guide us to our exit.
You can use the Keltner Channels with many different momentum based indicators but I find MFI works best.
I hope you enjoyed this little breakdown. As always... Good Luck and Happy Trading