Keltner Channels

Chester W. Keltner developed this technical indicator as an aid to the utilisation of volatility as a trading technique. This indicator is one of the families of channels and envelopes. The tendency of markets to be contained within an upper and lower parameter has long been known and utilised in the techniques known as channel trading.

Our study of fractal geometry has led to the realisation that these channels are actually the “structural beams” that form the structure of a market and they possess geometrical ratios that continue to repeat in the waves of both smaller and larger magnitude.

The trading techniques published by Mr Keltner suggested buying into a break above the upper band with the thought that a price move strong enough to breakout may well continue for some time. The same principle was espoused for taking short positions when the market broke below the lower band. In reality, it will be realised that while this technique may be successful on occasions, it is also often the case that a breakout through the bands signals the exhaustion of the move.

Traders using Keltner Channels will generally use some form of additional indication to confirm the Keltner signals. Th ese include the MACD and the RSI (Relative Strength Indicator). In our case we will use the Money Flow Index.

Wesfarmers inside a Keltner Channel This indicator is found under “averages” in the MarketAnalyst software. Note the propensity for reversals to occur at or near the bands.

The mathematical structure of a Keltner Channel is reasonably simple. A Moving Average is taken over the selected time frame using the High + Low + Close / 3 rather than just the closing price. Exponential averages were tried but make no significant difference.

The range that price moves during this period is multiplied by the moving average value and the result is multiplied by a constant. The most common default setting of this indicator is 10 periods and a constant of 1. It will become apparent that the trading rules, time frame and objectives will dictate the parameters used.

The parameters used in the examples in this paper are:

9 periods being half of the common 18 period cycle and a constant of 1.9 being a ratio to 18 that is “harmonic”.

Confirmation is sourced from a 6 period Money Flow Index oscillator located under the “Volume” tab in the MarketAnalyst program. 6 periods is 66% of the MA period providing a leading indication of future potential price action.

Experimenting with other combinations is encouraged.

Trading Rules

New Entry (long)

Place a trend band with the reference line (middle of the band) directly over the moving average on the vertical plane with the first step up by all three Keltner lines. Increase the trend band width until the upper and lower Keltner boundaries are touched.

Note the % value and halve it. In this case the band width is 3.6% either side of the reference. When then halve this reading so that the band decreases to 1.8% either side of the reference. The band was 7.2% and is now 3.6%. This 3.6% band now becomes our entry and exit “noise” criteria.

The 3.6% noise band is placed as a falling resistance line across the two tops and an entry is signalled on a break above the upper boundary of the trend band.

The trend is next placed on the top of the bar to act as a stop should price reverse sufficiently.

This next chart shows the band width cleared volatility until the price reversed to a greater extent than volatility.

This is a fair indication that the trend may be reversing.

An entry into a short position requires that the current volatility (half of the total width of the bands) be placed on the high and all three Keltner lines are stepping down and MF is down but not below 25.

The application of these principles can allow the trader to create an excellent trading system. Improvements include decreasing the width of the stop band by .1% each trading period (day, week) that the money flow index moves in the direction opposite to the trade.

The same parameters will also prove close to ideal for a weekly chart. The monthly chart will also reveal market conditions not necessarily evident in other trading strategies.