Keltner Channel for Forex Trading

Forex support and resistance indicator based on volatility

The Keltner Channel plots two bands around a central modified moving average and is similar to Bollinger Bands in the way the distance of the upper and lower bands from the average will vary according to the underlying volatility of price. As opposed to Bollinger Bands, which use standard deviation in the calculation, Keltner bands use Average True Range.

True Range was developed by J Welles Wilder Junior to represent the real highs and lows of the day to include possible gaps from the prior bar's close to the current bar's open. This is a tool that was intended more for the futures and equities markets where there is a significant time gap between the close and the following day's open. In this way, True Range is calculated by taking the maximum of:-

1. High - Low
2. The prior bar's close - Low
3. High - the prior bar's close

However, it is very unusual for these gaps to occur in the forex market since there is no time difference between one day's close and the next day's open. Thus a gap can only really effectively occur over weekends or during volatile market conditions.

A modified average is then taken of a series of True Range calculations. Clearly, if there has been a significant level of high range bars the upper and lower bands will move away from the average while a series of low range bars will cause the bands to move inwards towards the average. Thus Keltner Bands will automatically expand and contract as the market volatility rises and falls respectively.

Basic usage of the Keltner channels are two-fold:

1. In consolidating markets the upper and lower bands may be considered as approximate support and resistance where trades may be considered to take advantage of range trading.
2. Where price breaks cleanly through and closes outside one of the bands there is a higher risk of a trend in the direction of the break developing.
3. The central moving average may be used as a trailing stop when in a trending move

It is always recommended that trades are not initiated on the basis of one indicator only and utilizing other techniques such as momentum indicators (i.e., RSI, Stochastics, etc…) may be used in order to help confirm or deny the entry signals. Reference to price patterns is also preferred.

Parameter Defaults: Period = 12 (controls the measurement period for the average)
Factor = 1 (controls the placement of the bands around the average)

Plots:

Upper KC Upper Band line
Mid KC Central Moving Average
Lower KC Lower Band line

Formula:

Mid KC = "Period" length modified moving average
Upper KCv = Mid KC + "Period" length Average True Range x Factor
Lower KC = Mid KC - "Period" length Average True Range x Factor

Keltner Channel for Forex Trading

Forex support and resistance indicator based on volatility

The Keltner Channel plots two bands around a central modified moving average and is similar to Bollinger Bands in the way the distance of the upper and lower bands from the average will vary according to the underlying volatility of price. As opposed to Bollinger Bands, which use standard deviation in the calculation, Keltner bands use Average True Range.

True Range was developed by J Welles Wilder Junior to represent the real highs and lows of the day to include possible gaps from the prior bar's close to the current bar's open. This is a tool that was intended more for the futures and equities markets where there is a significant time gap between the close and the following day's open. In this way, True Range is calculated by taking the maximum of:-

1. High - Low
2. The prior bar's close - Low
3. High - the prior bar's close

However, it is very unusual for these gaps to occur in the forex market since there is no time difference between one day's close and the next day's open. Thus a gap can only really effectively occur over weekends or during volatile market conditions.

A modified average is then taken of a series of True Range calculations. Clearly, if there has been a significant level of high range bars the upper and lower bands will move away from the average while a series of low range bars will cause the bands to move inwards towards the average. Thus Keltner Bands will automatically expand and contract as the market volatility rises and falls respectively.

Basic usage of the Keltner channels are two-fold:

1. In consolidating markets the upper and lower bands may be considered as approximate support and resistance where trades may be considered to take advantage of range trading.
2. Where price breaks cleanly through and closes outside one of the bands there is a higher risk of a trend in the direction of the break developing.
3. The central moving average may be used as a trailing stop when in a trending move

It is always recommended that trades are not initiated on the basis of one indicator only and utilizing other techniques such as momentum indicators (i.e., RSI, Stochastics, etc…) may be used in order to help confirm or deny the entry signals. Reference to price patterns is also preferred.

Parameter Defaults: Period = 12 (controls the measurement period for the average)
Factor = 1 (controls the placement of the bands around the average)

Plots:

Upper KC Upper Band line
Mid KC Central Moving Average
Lower KC Lower Band line

Formula:

Mid KC = "Period" length modified moving average
Upper KCv = Mid KC + "Period" length Average True Range x Factor
Lower KC = Mid KC - "Period" length Average True Range x Factor

Why is Elliott Wave so Useful?

The most accurate method of forecasting

The first time I came into contact with Elliott Wave was in my first seminar on technical analysis by a U.K. analyst. After the two day introductory course to analysis I returned to my trading room full of enthusiasm, armed with all the patterns and techniques this guru had imparted upon the fledgling analysts, ready to take the market by storm.

However, he clearly he didn't think very much about the principal since his only comment was "wave bye-bye to Elliott Wave."

So what did I have left?

• Golden crosses and dead crosses. Tried those - they were almost 100% the opposite of what he taught.
• Overbought & oversold momentum. Well good but they don't tell you where price is going and perform so badly in a trend.
• Reversal patterns and continuation patterns. Well they didn't happen that frequently and what were you meant to do in the meantime? My traders wanted to know where price was going to go.

I began to read more. Ah! Fibonacci! 38.2% and 61.8% - wow they worked really well… I thought I found the secret elixir to the fountain of profits… Then they suddenly didn't work.

Desperate for clues I read other analysts' commentary on the data vendor platforms. Some provided anemic comments while others actually forecast exact targets and how it would reach there. Some were ok, some were bad (but enthusiastic) and some were actually pretty good. This fascinated me. Who were these guys that were actually forecasting where price would go? How did they do that? The answer was Elliott Wave and it was these services that actually provided real information and had the greatest rate of success.

So I decided to read about Elliott Wave and tried to teach myself. Of course I didn't tell my guru - I didn't want to incur his wrath.

I can guess what some of you are thinking, "yeah, yeah, 12345 ABC." Well basically, yes. But it is a lot more. I bought a couple of books, devoured them and went to my charts to decipher and scribble numbers and letters all over them. It wasn't as easy as the books made them out to be. It was a struggle trying to decide where waves started and ended and how far they would move and I did give up for a period but the problem was that nothing else really gave true forecasting techniques.

So I persisted. I did my analysis and I read other banks' forecasts and tried to work out why they were right - or indeed, why they were wrong. I have to say it took me around 18 months before I felt comfortable using the principal to forecast, and even then it was still a little hit & miss.

As with any form of analysis there are good points about Elliott Wave and there are bad points. The bad points are:

• The counting of waves can be very subjective. There is a common joke that says: "Place 5 Ellioticians in a room with 1 chart for one hour and they'll come out with 20 different wave counts". True…
• The development of individual waves can vary dramatically
• The experience required to recognize the type of variation takes a good few years and a great deal of patience to acquire
• Sometimes waves are impossible to recognize
• Filtering wave counts to obtain the most likely ones can be difficult
• Elliott's description of the wave structure is actually incorrect for Foreign Exchange - a fact that took me many years to realize
• Once you start using the principal it is impossible to look at a chart without counting waves…
• It can cause you to make incredibly inaccurate forecasts if not utilized properly. (I recall one analyst that called USDDEM higher from 1.72 to 2.46 and 3.46… it actually went down to 1.44…)

Against that the good points are:

• Elliott Wave can predict market moves to the point at times - nothing else can
• Waves are related and thus you can use Fibonacci relationships to recognize waves, where they started and where they have greatest chance of ending
• It tells you how a move will occur. This is vital
• It will warn you that your wave count may be breaking down if the wave development doesn't go as planned
• It is the only form of analysis (that I know of) that gives you an understanding of market behavior as if it is an extension of a living force
• The principal helps an analyst/trader to understand the structure of a market from monthly charts down to 1 minute charts, a reflection of the fractal nature of markets.
• It can provide incredibly easy trades from time to time just using basic guidelines

The biggest element to success with Elliott Wave, apart from several years of experience, is understanding how to filter your wave counts. The very best way is to understand the cyclical nature of the market forces. If the analyst who had predicted USDDEM to move higher to 2.46 and 3.46 had incorporated cyclic analysis he would have seen that the major cyclic pressure was still lower. That in itself will keep you closer to the right count. Cycles have assisted me in recognizing direction to moves and when they should reverse - which combined with Fibonacci projections to structures can allow precise forecasting.

Momentum analysis can help you recognize when the pattern you have been following is breaking down and become more complex. Even a basic guidelines that the last Wave B will provide approximate support or resistance on retest can produce excellent trading opportunities.

So now what are you waiting for? Go pick up a book on the Principal but remember nothing is easy in this market and it will take time and dedication. If there was a simple solution then everyone would use it. If everyone used it, then it probably wouldn't work so well…

How I use Bollinger Bands in My Trading

The Bollinger Bands (B-Bands) technical study was created by John Bollinger, the president of Bollinger Capital Management Inc., based in Manhattan Beach, California. Bollinger is well respected in the futures and equities industries.

Traders generally use B-Bands to determine overbought and oversold zones, to confirm divergences between prices and other technical indicators, and to project price targets. The wider the B-bands on a chart, the greater the market volatility; the narrower the bands, the less market volatility.

B-Bands are lines plotted on a chart at an interval around a moving average. They consist of a moving average and two standard deviations charted as one line above and one line below the moving average. The line above is two standard deviations added to the moving average. The line below is two standard deviations subtracted from the moving average.

Some traders use B-Bands in conjunction with another indicator, such as the Relative Strength Index (RSI). If the market price touches the upper B-band and the RSI does not confirm the upward move (i.e. there is divergence between the indicators), a sell signal is generated. If the indicator confirms the upward move, no sell signal is generated, and in fact, a buy signal may be indicated.

If the price touches the lower B-band and the RSI does not confirm the downward move, a buy signal is generated. If the indicator confirms the downward move, no buy signal is generated, and in fact, a sell signal may be indicated.

Another strategy uses the Bollinger Bands without another indicator. In this approach, a chart top occurring above the upper band followed by a top below the upper band generates a sell signal. Likewise, a chart bottom occurring below the lower band followed by a bottom above the lower band generates a buy signal.

B-Bands also help determine overbought and oversold markets. When prices move closer to the upper band, the market is becoming overbought, and as the prices move closer to the lower band, the market is becoming oversold.

Importantly, the market's price momentum should also be taken into account. When a market enters an overbought or oversold area, it may become even more so before it reverses. You should always look for evidence of price weakening or strengthening before anticipating a market reversal.

Bollinger Bands can be applied to any type of chart, although this indicator works best with daily and weekly charts. When applied to a weekly chart, the Bands carry more significance for long-term market changes. John Bollinger says periods of less than 10 days do not work well for B-Bands. He says that the optimal period is 20 or 21 days.

Like most computer-generated technical indicators, I use B-Bands as mostly an indicator of overbought and oversold conditions, or for divergence--but not as a specific generator of buy and sell signals for my trading opportunities. It's just one more "secondary" trading tool, as opposed to my "primary" trading tools that include chart patterns and trend lines and fundamental analysis.