The wider the period size you choose the smoother the bands will appear and the larger the deviation the wider the bands are. This is in a similar respect to Bollinger Bands as with both the indicators the bands will move further apart.
How to Trade
This method was suggested by Keltner himself for breakout trades. When the price breaks above the upper line you would go long and if it crosses the lower line you would go short the market.
The main issues with this type of strategy, it can be very volatile returns which is common with breakout strategies. You will get multiple false breakouts where the price will go above or below the upper and lower lines but then it returns to the previous level. As you can imagine these false breakouts will result in losses. This will result in large drawdowns.
One way around this is to use this in connection with another break out chart patterns to help you confirm if it is a real or false breakout. This can be indicators such as head and shoulders, wedge or looking at the candlesticks.
This method can use the same setup as above or you can create another band on each side by overlaying two Keltner indicators but if the indicator only allows one you can use the outer sides of the bands for reference. Obviously, you can use much more bands if you would like.
You will need to create a histogram for all 4 gaps.
This histogram will record the amount of time the price has traded between each band. This is easier to do with automated software but can still be done manually by trades by counting boxes.
You will then need to place this information into a table.
|Gap||Gap 1||Gap 2||Gap 3||Gap 4|
The count is the number of time the center bar of the candle is within the band. Using these figures this method helps to show where the market strength is and helps to predict the future movement.
Skewed to the left – When it is skewed to the left the indicator is suggesting the strength is on the downside.
Skewed to the right – When it is skewed to the right the indicator is suggesting the strength is on the upside.
Neutral – The market is balanced.
It is Important to realize this method is not looking at trend such as many other indicators. The distribution of the histogram can still neutral even if the market is rising or falling. It measures the changes in the market where it is diverging away from its recent path. Due to it using multiple bars to calculate.
The Keltner channels have been around since the 60s and are mainly used on breakout events. The signals will appear when the price line crosses over one of the Keltner lines.
There are multiple versions of this but the main idea is the same, use multiple moving averages that form a middle, upper and lower range line. The upper and lower lines create the channel and measure deviations of the price around the central axis similar to the Bollinger Bands.
Main Line – EMA (Blue)
Upper line – EMA + EMA period length x deviation size (Red)
Lower Line – EMA – EMA period length x deviation size (Red)