Trading BSE stocks with Keltner Channels 

Keltner channels all fall into the general category of envelopes, which consist of three lines – a middle line and two outer lines. Envelope theory holds that price has the greatest probability of falling within the boundaries of the envelope. Stock market price falling outside the envelope boundaries is considered an anomaly and therefore provides a trading opportunity.

It may be used in place of standard deviation (Bollinger) bands or percentage envelopes.

Originally, Keltner had his system buy when the close exceed the upper channel and sell when the close was below the lower channel. Basically, penetration exceeding the channels showed a strong bullish or bearish momentum and presumably the momentum would continue.

However, there is no reason why not to use Keltner Channels the same way as other price envelopes such as Bollinger Bands. When using Bollinger Bands ninety five percent of price movement occurs within the bands. The upper and lower bands are considered as extremes of the price movement and are a warning that price exhaustion may be occurring. Buy signals occur when the price is below the lower band and sell signal occur when price exceeds the upper band.

Calculation of Keltner Channels

Construction of Keltner Channels is simple. You have a mid band based on the average of the high, low and closing price with a band on each side formed from a 9 simple moving average of the daily high minus the daily low. This would be represented as:

Average Price (AP) = (C+H+L)/3
Band Moving Average = 9Day Simple Moving Average (SMA)
of (High – Low)
Middle Moving Average = 9Day SMA of AP
Upper Band = Middle Moving Average + Band MA
Lower Band = Middle Moving Average – Band MA

Keltner Channels work great in any time frame, the more trending the market, the better chance for success using the Keltner Channel.

Trading example

Below is a daily chart of the BSE Sensex with the Keltner Channel set at 9. We are looking for price breakouts outside the channel (Green area) with the candle not only outside or touching the line but having also closed outside the upper line of the Keltner Channel.

We will add a filter to identify our trades as usual and in this case we like to use the Commodity Channel Index (CCI) set at 14. Below is the same daily chart of the BSE Sensex again, this time with the CCI set at 14.

Trading rules (Going Long)

1. Have your chart set up with the CCI indicator at 14 and Keltner Channel setting at 9.
2. Enter long whenever price closes outside the upper line of the Keltner Channel TOGETHER with the CCI crossing into overbought as shown on the chart above.
3. Your stop loss/exit will be the first candle closing below the lower Keltner Channel line.
4. For a target you could employ a 30 pip trailing stop or use Fibonacci expansions. (We will have a lesson on Fibonacci in the future if you are not familiar with it).

Conclusion

As with all trend following systems, the Keltner Channel works well in up trends or down trends, but doesn't work well in a sideways channel. As a trend following system it is not meant to catch tops or bottoms and should be used in combination with other indicators, such as RSI or MACD, to provide confirmation of the strength of a market.

Thank you for joining us in this stock trading lesson.

The Indiadaytrading Team