The vast majority of effort spent by a technical analyst to assess current market conditions is related to finding an asset price that is close to a balanced value. In simple words, the technical analysis aims to calculate an average rate in a given period. With that in mind, traders compare the current price action to the average mean, making conclusions about the direction of a trend, its strength and momentum, measuring volatility and the speed of price action, and predicting the future market sentiment, using the Keltner Channel (mt4).
However, given the frequent fluctuations of financial assets and often whipsaws reflecting false movements, it becomes a tough challenge to get a precise figure of an average rate. This is why technical analysts always focus on ranges or bands, which are crucial for the overall equation at the end of the day. Effectively, that is why technical indicators became so popular in binary options trading. This article aims to provide an in-depth guide for one of the most effective envelope indicators, the Keltner Channel.
Keltner Channel explained
The strategy is based on a multi-purpose indicator, which shows the market volatility, trend’s direction, and strength, oversold and overbought conditions, as well as the average balanced price level. It is very similar to the widely used Bollinger Bands indicator, however, Chester Keltner - the developer of the indicator - represented a different way of measuring average ranges in the 1960s. His initial formula was based on Simple Moving Averages, but in the 1980s, a new method was offered - Exponential Moving Average and Average True Range.
THE FORMULA BEHIND THE AVERAGE
Before getting into the details of how the calculation is made, it’s worth explaining several crucial methods used in the formula, as well as their advantages in terms of practical use in binary options trading. Exponential Moving Average (EMA), in contrast to simple Moving Average (MA), has an additional constant of smoothing values. In other words, EMA is much more sensitive to price changes than SMA, and it has a less lagging distance. Thus, using EMAs in any indicator’s formula allows technical analysts to make more accurate predictions of resistance & support levels, breakthrough ranges, and reach a higher accuracy of the indicator as a result.
Average True Range (ATR) has even more layers of smoothing out unnecessary market noise. The formula picks up a maximum value between the difference in a high and low rate, absolute means of high rate less the previous close, and absolute mean of low price less previous close. After that, ATR is calculated by dividing 1 by the number of periods and multiplied by the sum of all previous readings for the chosen period. The main advantage of ATR compared to SMA is that it excludes false whipsaws and too large spikes of the price to calculate ranges where the rate was present more often. As a result, ATR points to a more probable price range in the future.
Keltner`s formula is as follows:
- Middle Line = EMA;
- Upper Band = EMA + 2 * ATR;
- Lower Band = EMA - 2 * ATR.
Keltner Channel settings:
The indicator can be adapted to any kind of trading strategy in terms of binary options expiration time and periods of analysis.
The settings behind the Keltner Channel trading strategy have three key parameters to choose:
- EMA period (typically 20 bars);
- ATR period (typically 20 bars);
- And the multiplier (2 as the default).
Additionally, technical analysts can also select the method of calculation at terms of applying the formula to close, high or low prices, using ATR or TR, and measuring the band with SMA or EMA.
All the settings have a direct impact on the range amplitude and sensitivity of the indicator. For example, if a trader prefers using many entries on short-term timeframes such as 60-minutes or less, then it’s worth decreasing the period of calculation as the goal is to catch short-term fluctuations and benefit on from a large number of trading positions.
If a binary options trader is keen on using the buy-and-hold strategy to hedge his risks for a long-term period, then he would not pay too much attention to small and insignificant price action, ignoring small short-term trends. In this case, a larger period of the moving average would be more effective as the band will become wider and the number of extreme values will be reduced as well.
Some technical analysts prefer implementing Fibonacci numbers when it comes to setting indicators’ periods. For example, the 21-days range might be more effective than 20 days or 13-bars instead of 14-bars.
The multiplier (X2 in the formula above) influences the band’s range and thus it points to moments of higher and lower volatility. It’s recommended to shorten the choice to a range between 1 or 2 as a higher multiplier would expand the amplitude of the moving average too much, lowering the number of trading signals. Nevertheless, all of the settings have to be tested on a demo account before implementing the Keltner channel trading strategy in real-money conditions.
If you like this strategy, you might also be interested in this Darvas Box Trading Strategy
Benefit from channel trading
The Keltner Channel Strategy is a multi-purpose technique as it provides a lot of information about current and future market conditions to a binary options trader.
First of all, the angle of strategy bands points to the current trend direction, reflecting not only the sequence of higher highs for an uptrend or lower lows for a downtrend but also indicating the shift in the average range of the underlying asset price.
Secondly, if an asset quote remains above or below the upper or lower band, then the bullish/bearish trend has comparatively strong momentum and the likelihood of a continuation in the same direction is high. Comparing the two factors mentioned above, traders could decide whether to confirm or deny the recent trading signal as if the action comes in line with the indicator, then the chance of profitable trade increases. For example, if the price remains above the band and the channel is headed upwards, then the technical sentiment is bullish, according to the Keltner Channels, and buying call options is more attractive. Alternatively, if a quote stays below the bottom band constantly, and the channel’s angle is headed south, then the bearish condition weighs on the market’s sentiment, and traders prefer buying put options.
Third, when rates are constantly testing the upper/lower band with no significant breakthrough and development, then it is possible to assume that the recent trend is getting exhausted and the likelihood of a reversal is increasing. For instance, if the uptrend failed to continue, while recent prices could not breach the upper band, then buying put options becomes more attractive, counting on a possible bearish reversal. The same situation could be used for buying put options when the downtrend is losing momentum and an asset price is unable to break through the bottom band.
Fourth, during a sideways consolidation when the price action is directionless, and rates touch the upper band after bouncing off the lower line of the average line several times in a row, then binary options traders could take advantage of multidirectional trading, buying call and put options following appropriate signals.
Keltner channel (mt4)
As long as the moving average has a wide range of different patterns related to various market conditions, all of the practical implementations have to be considered separately. Before exploring trading examples, it’s worth getting on the same page in terms of the indicator’s settings that are available through MegaTrader 4 (mt4)
Regardless of any exact timeframe used in the examples below, the settings will be the same unless otherwise noted:
- The length (period) is equal to 21 bars;
- The multiplier is set to 2;
- The source of calculation is the close rate;
- The formula uses EMA and ATR.
Practical examples of implementing the strategy to binary options trading will also include such a term as trading cycles. The main idea is to keep buying the same options (call or put depending on the signal) in a certain period until the opposite signal occurred.
Buying put options in a long-term downtrend on bullish retracements
The screenshot below shows the long-lasting downtrend of EUR/USD on the daily timeframe. The Keltner Channel indicator has a constant descending angle, confirming the overall trend direction. However, like any strong trend, the bearish trade has to have healthy retracements - short periods when the market is keen on charting bullish performance. The trading method shown below shows several profitable signals from the Keltner Channel, which highlighted a moment when the bullish retracement came to an end. Red arrows indicate the start of the trading cycle to buy put options, while the green ones point to the end of the cycle. The trading signals came when EUR/USD was reaching the peak of the bullish retracement, and daily close rates failed to breach the Keltner Channel upper band, charting long whipsaws on daily candlesticks. Both factors indicate that the bulls were exhausted and the upside swing lost the momentum, pointing to a bearish reversal and the beginning of the downswing. Deals were profitable until the exchange rate reached the bottom line, closing a day above it.
Buying call options after bearish bounces within a strong uptrend
Below is an hourly chart showing a strong intraday uptrend of USD/JPY. The trading method is the same as per the previous example but mirrored. Binary options traders wait for the underlying asset price to bounce back down to the bottom band, and start buying call options on a failed test of the support. Long shadows on hourly candlesticks are used as a confirmation signal, pointing to strong demand from call-option buyers at a certain level. One more notable difference is that some strong trends might not give the full depth of retracement toward the bottom line, thus buying call options would also be profitable after the rate tested the middle line but failed to breach it with the close price.
Trend reversal with overbought/oversold conditions
The USD/CAD one-hourly chart below shows a perfect example of a trend’s reversal when reaching overbought conditions. The initial uptrend was over when three entry conditions were met. First, the rate bounced off the overbought territory and entered the channel from above after charting a sequence of long upper shadows. Second, an hourly close rate appeared below the upper resistance line, and the angle of the average line was changed. Third, the price confirmed the trend reversal after closing below the middle line. However, once USD/CAD charted a bounce back North, and closed an hour inside the channel after trading below the support curve, the trading cycle of buying put options was stopped under the opposite signal. The red arrow had a similar trading signal described above, and the trading cycle was repeated.
Buying call and put options in a sideways consolidation range
This trading technique is especially applicable to currency cross-rates such as EUR/GBP, AUD/NZD, CHF/JPY as those pairs are vulnerable to directionless trades more often than major pairs. The example below illustrates USD/CAD in a consolidation intraday action on the one-hourly timeframe. The strategy works well pointing to extreme values and reversal conditions when overbought and oversold levels are tested. Binary options traders should use the same entry conditions as mentioned in the previous examples, keeping in mind that the underlying asset might keen on hovering around the middle line for a longer period than in a strong trend.
USING THE STRATEGY WITH BOLLINGER BANDS
Due to the difference in calculation of upper and lower bands, the strategy described and Bollinger Bands have significant distinctions in visual representations and practical performance of trading patterns used to analyze the market conditions and provide trading signals.
For example, asset quote trade outside the targeted bands much more often compared to Bollinger Bands. The interpretation of those signals might also be different as BB breakthroughs are used for reversal signals, while KC admits buying options in the same direction even if the rate constantly remains outside the channel. However, both indicators have various settings allowing traders to enlarge or squeeze the band's width, take into account larger or shorter periods, adjust sensitivity, and influence the frequency of trading signals. All of the variables have a direct impact on individual trading strategy and have to be considered concerning any particular case and trading conditions. What’s more, different currency pairs and asset classes might vary in terms of volatility, liquidity, and trading volume, thus the performance of both technical indicators might differ as well. Nevertheless, both indicators represent the family of envelope indicators with a similar mathematical approach. Therefore, they have the same advantages and limitations, which might be filtered with additional indicators with other types of formulas. The screenshot below shows a comparison of the strategy described vs Bollinger Bands with the same period on the daily chart of Gold.
BOLLINGER BAND INDICATOR INSIDE THE STRATEGY
Traders can benefit from the differences between the two indicators mentioned above. One of the practical implementations of such a combination is called Bollinger Band squeeze. The main idea is that when the price action is comparatively quiet and stable, BB remains inside the band of the strategy. However, if the volatility is rising, and a new trend starts, Bollinger Bands expands the surplus between its lines, getting out of our band. In that case, a buy or a sell signal occurs depending on the direction of the breakout.
Below is an example:
The Keltner Channel Strategy aims to provide a wide variety of technical analysis data to predict the market’s conditions, show overbought and oversold levels, point to volatility, and trend’s direction. The keltner channel indicator belongs to the family of envelope indicators and it’s similar to Bollinger Bands with the same set of strengths and weaknesses. At the same time, due to the different methods of calculating the average and smoothed values, the strategy might increase practical implementation and performance in terms of precise trading signals. The wide selection of technical parameters and settings allows adapting the Keltner Channel to any individual trading strategy based on technical indicators.