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Technical Indicators: Keltner Channels
Deviation Channels
One of the best kept secrets is this standard deviation channel indicator. Although
it looks very similar to the Bollinger Bands, it has different yet powerful
characteristics that set itself apart from other indicators. It can be used to
follow the trend as well as counter-trend trading.
Chester W. Keltner came up
with this formula and tested exhaustively to make sure the indicator works. It
was originally developed this indicator to trade the commodity markets but is
used by many in different markets. Although the indicator can be used for
trending trading, its strength lies in trading within the channel.
The chart below shows that prices spend 95% of the time inside the channel.
Using this channel can help identify where exhaustions in direction are taking
place.
When the extreme prices
move outside the channel, there is a tendency for them to reverse and move back
inside it. One caveat is that the channel also move. In this case, if the
market is in a strong trend, prices may consolidate but would not move back to
the channel, instead the channel will move towards the prices.
Understanding this
interpretation can help identify which market condition is at work: trend or
range. From the chart above, the downtrend was swift and the channel moved
quickly down with them. When the prices rallied shown in the blue shaded box,
it was only a short distance and prices were already inside the channel. When
the rally ended, prices used the middle line as resistance and headed further
down. So when trends are strong, the channel moves sharply down with it.
How does one trade with this indicator?
The first step is to
identify the channel and their direction. If they are moving up, the market is
bullish, if they are moving down, then the market is bearish. This is important
as it indicates whether to trade the trend or the range. When in a trend, the
prices are usually outside the channel more often than it is inside the
channel. They only move back inside when they are consolidation or reacting
before taking another move. And when this happen, these prices will touch
either the top or middle lines (for bullish trends), and bottom or middle lines
(for bearish trends). When these prices pull back, watch the bar that penetrates
the line. From that line, watch for the reversal, if it does occur, that is the
cue to make the entry.
The chart above shows the
prices in an uptrend. Prices stayed outside the channel most of the time. When
they started to consolidate, the channel caught up with prices and moved to
just above the bottom line, but not penetrating it. The blue shaded boxes show
the consolidation and also the move back toward the primary direction, in this
case, upwards. The entry is placed when the prices move higher than the
previous bar's high.
As for the trendless or
range-bound trade, the channel move sideways. This action indicates that a
trendless range is in play.
The blue shaded boxes
above the upper channel show the channel penetrating the channel above then
move back down. The weakness in prices indicates a trendless market. Below the
bottom channel are the prices showing penetration but no follow-through to take
the prices lower. As can be seen prices on top of the channel are best shorted
when they move away from the top extreme area while the prices below the
channel are best long when they move away from the extreme areas toward the
middle of the channel.
The Keltner channel works
in both trend and trendless markets. It requires some time to understand the
indicator and its relationship to price action. Once the trader has this
foundation, the signals will become clear for him to profit from them. Keltner
channel indicator can be found in SwingTracker.com charting software.
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