Keltner Channels

 

Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands.

Flashback to , when I was just starting out in day trading; I had no idea what I was doing. Now some traders can take the elementary trading approach of shorting the stock on the open with the assumption that the amount of energy developed during the tightness of the bands will carry the stock much lower.

BREAKING DOWN 'Bollinger Band®'

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In the s, John Bollinger, a long-time technician of the markets, developed the technique of using a moving average with two trading bands above and below it. Standard deviation is a mathematical formula that measures volatility , showing how the stock price can vary from its true value. This is what makes them so handy for traders: Read on to find out how this indicator works, and how you can apply it to your trading.

The center line is an exponential moving average ; the price channels are the standard deviations of the stock being studied. The bands will expand and contract as the price action of an issue becomes volatile expansion or becomes bound into a tight trading pattern contraction. Learn about the difference between simple and exponential moving averages by checking out Moving Averages: A stock may trade for long periods in a trend , albeit with some volatility from time to time.

The crux of the Bollinger Band indicator is based on a moving average that defines the intermediate-term "trend" based on the time frame you are viewing. This trend indicator is known as the middle band. Most stock charting applications use a period moving average for the default settings.

The upper and lower bands are then a measure of volatility to the upside and downside. They are calculated as two standard deviations from the middle band. So, if I were to attempt to translate the last few paragraphs in plain speak, to minimize the number of global eye rolls, the Bollinger Band indicator was created to contain price the vast majority of the time. Regardless of the trading platform, you will likely see a settings window like the following when configuring the indicator.

If you are new to trading, you are going to lose money at some point. This process of losing money often leads to over-analysis. While technical analysis can identify things unseen on a ticker, it can also aid in our demise. In the old times, there was little to analyze. Therefore, you could tweak your system to a degree, but not in the way we can continually tweak and refine our trading approach today.

Case in point, the settings of the bands. While the configuration is far simpler than many other indicators, it still provides you the ability to run extensive optimization tests to try and squeeze out the last bit of juice from the stock.

The problem with this approach is after you change the length to My strong advice to you is not to tweak the settings at all. It's better to stick with 20, as this is the value most traders are using to make their decisions. Now that we have covered the basics let's shift our focus over to the top 6 Bollinger Bands trading strategies. Before we jump into the strategies, look at the below infographic titled '15 Things to Know about Bollinger Bands'. The information contained in the graphic will help you better understand the more advanced techniques detailed later in this article.

Well, the indicator can add that extra bit of firepower to your analysis by assessing the potential strength of these formations. Let's unpack each strategy, so you can identify which one will work best with your trading style. The first bottom of this formation tends to have substantial volume and a sharp price pullback that closes outside of the lower Bollinger Band.

These types of moves typically lead to what is called an "automatic rally. After the rally commences, the price attempts to retest the most recent lows that have been set to challenge the vigor of the buying pressure that came in at that bottom.

Many Bollinger Band technicians look for this retest bar to print inside the lower band. This indicates that the downward pressure in the stock has subsided and there is a shift from sellers to buyers. Below is an example of the double bottom outside of the lower band which generates an automatic rally. In addition, the candlestick struggled to close outside of the bands. Another simple, yet effective trading method is fading stocks when they begin printing outside of the bands.

Now, let's take that one step further and apply a little candlestick analysis to this strategy. For example, instead of shorting a stock as it gaps up through its upper band limit, wait to see how that stock performs.

If the stock gaps up and then closes near its low and is still entirely outside of the bands, this is often a good indicator that the stock will correct on the near-term. You can then take a short position with three target exit areas: As you can see from the chart, the candlestick looked terrible. The single biggest mistake that many Bollinger Band novices make is that they sell the stock when the price touches the upper band or buy when it reaches the lower band.

Bollinger himself stated a touch of the upper band or lower band does not constitute a buy or sell signal. Notice how the volume exploded on the breakout and the price began to trend outside of the bands; these can be hugely profitable setups if you give them room to fly.

I want to touch on the middle band again. Just as a reminder, the middle band is set as a period simple moving average in many charting applications.

The middle line can represent areas of support on pullbacks when the stock is riding the bands. You could even increase your position in the stock when the price pulls back to the middle line.

Regarding identifying when the trend is losing steam, failure of the stock to continue to accelerate outside of the bands indicates a weakening in the strength of the stock. This would be a good time to think about scaling out of a position or getting out entirely. Another trading strategy is to gauge the initiation of an upcoming squeeze. John created an indicator known as the band width.

The idea, using daily charts, is that when the indicator reaches its lowest level in 6 months, you can expect the volatility to increase. This goes back to the tightening of the bands that I mentioned above.

This squeezing action of the bollinger band indicator foreshadows a big move. You can use additional signs such as volume expanding, or the accumulation distribution indicator turning up. We need to have an edge when trading a bollinger band squeeze because these setups can head-fake the best of us. It immediately reversed, and all the breakout traders were head faked. You don't have to squeeze every penny out of a trade.

Wait for some confirmation of the breakout and then go with it. If you are right, it will go much further in your direction. Notice how the price and volume broke when approaching the head fake highs yellow line. To the point of waiting for confirmation, let's look at how to use the power of a Bollinger Band squeeze to our advantage. Notice how leading up to the morning gap the bands were extremely tight.

Now some traders can take the elementary trading approach of shorting the stock on the open with the assumption that the amount of energy developed during the tightness of the bands will carry the stock much lower.

Another approach is to wait for confirmation of this belief. So, the way to handle this sort of setup is to 1 wait for the candlestick to come back inside of the bands and 2 make sure there are a few inside bars that do not break the low of the first bar and 3 short on the break of the low of the first candlestick.

Based on reading these three requirements you can imagine this does not happen very often in the market, but when it does, it's something else. The below chart depicts this approach. Now let's look at the same sort of setup but on the long side. Below is a snapshot of Google from April 26, Notice how GOOG gapped up over the upper band on the open, had a small retracement back inside of the bands, then later exceeded the high of the first candlestick.

These sorts of setups can prove powerful if they end up riding the bands. This strategy is for those of us that like to ask for very little from the markets. Essentially you are waiting for the market to bounce off the bands back to the middle line. You are not obsessed with getting in a position and it wildly swinging in your favor. Nor are you looking to be a prophet of sorts and try to predict how far a stock should or should not run.

By not asking for much, you will be able to safely pull money out of the market on a consistent basis and ultimately reduce the wild fluctuations of your account balance, which is common for traders that take big risks.

The key to this strategy is waiting on a test of the mid-line before entering the position. You can increase your likelihood of placing a winning trade if you go in the direction of the primary trend and there is a sizable amount of volatility. As you can see in the above example, notice how the stock had a sharp run-up, only to pull back to the mid-line. You would want to enter the position after the failed attempt to break to the downside. You can then sell the position on a test of the upper band.

If you have an appetite for risk, you can ride the bands to determine where to exit the position. Put simply, a hedge fund is a pool of money that takes both short and long positions, buys and sells equities, initiates arbitrage, and trades bonds, currencies, convertible securities, commodities. The loan can then be used for making purchases like real estate or personal items like cars.

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