Keltner Channel Momentum Forex Trading Strategy

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Keltner Channel Momentum Forex Trading Strategy

Momentum strategies are a staple in many professional scalpers arsenal of strategies. Having one is definitely a must have for any trader looking to make money from the forex markets.

Momentum strategies are based purely on force. The idea is that price sometimes moves with so much force, breaking through supports and resistances, it can’t help but continue on further even just a bit. Think of it as price being a freight truck moving at a hundred miles per hour. Even if there was a brick wall that it would crash into, which is our supports and resistances, it would still move a few meters. That is momentum. That is what we would want to make money from.

The Keltner Channel Indicator

Now, let me introduce to you the only indicator that we will be using in this strategy, the Keltner Channel Indicator. So, what is it? The Keltner Channel is a simple indicator introduced by Chester Keltner in his book, How to Make Money in Commodities, during the 1960’s. Given the background of when this book was written gives us an idea how simple this indicator is. Have in mind that during that time powerful computers are still hard to come by. What Keltner needed was an indicator that could assist him reading his charts visually, but at the same time is simple to compute. What he had come up with is the Keltner Channel, a simple, no fuss, easy to compute indicator, which could make reading charts much easier to the right person.

What the Keltner Channel has are two very basic indicators – a Moving Average and the Average True Range (ATR). These two indicators used in tandem is already very powerful.

First, the Moving Average. By having the moving average, one would have a clue regarding the direction of the trend, or at least the short-term trend, if using the standard 20 period moving average. Another thing you would get out of it is an idea of whether price is respecting that trend by not whipsawing it back and forth too often. And lastly, you could also get and idea with regards to the strength of the trend by the steepness of the angle of the Moving Average.

Then you have the Average True Range (ATR). By having the ATR, you would have an idea of whether the candle lengths are within the average or are getting longer. Shorter candles which are contained by the Keltner Channel and are just around a quarter of the width of the channel could mean contraction or a quiet market. Longer candles on the other hand could mean expansion, volatility, and even momentum. This is what we will be exploiting in this strategy.

Just to give you an idea of how the Keltner Channel looks like, below is a screen shot of a chart with the indicator.

Keltner Channel Versus Bollinger Bands

At first glance, you would notice that it does look like a Bollinger Band. Yes, it is somewhat similar to a Bollinger Band but with a few very important differences.

First, the Bollinger Bands usually use the Simple Moving Average (SMA) while the Keltner Channel usually uses the Exponential Moving Average (EMA). Personally, I prefer using the EMAs as I find it to be more responsive and tends to hug price even tighter. It is just my personal preference though.

Secondly, the Bollinger Bands use Standard Deviations for its outer bands, while the Keltner Channel uses a simple, straight forward Average True Range (ATR) with a multiplier. This somehow allows the Keltner Channel to have a tighter band.

By being as straight forward as using an ATR, it is easier to assess momentum. By merely seeing that a candle has closed outside the band, we could say that the candle is more than twice the size of an average candle. This could mean strong momentum, which is the premise of this strategy.

The Setup: Using Keltner Channel for a Momentum Setup

So, how do we trade the Keltner Channel?

There are several ways to trade the Keltner Channel. Some would trade retracements to the mid-line. However, since we are doing momentum trades, what we will be looking for is a strong thrust outside the bands indicating a strong momentum.

Buy Entry:

  • Wait for a sudden thrust that closes beyond the upper outer band.
  • Enter a buy market order as the candle closes beyond the upper outer band.

Stop Loss: A few pips below the entry candle.

Exit: Close the trade as soon as a candle closes back within the bands.

Sell Entry:

  • Wait for a sudden thrust that closes beyond the lower outer band.
  • Enter a sell market order as the candle closes beyond the lower outer band.

Stop Loss: A few pips above the entry candle.

Exit: Close the trade as soon as a candle closes back within the bands.

Conclusion

The Keltner Channel is a good indicator to use to identify strong momentum. This is because of the simple idea that a close beyond the outer band by a candle that came from the middle means the candle is significantly larger than the average. This type of setup is a good start for a momentum strategy.

However, this type of setup is not without fault. Some closes beyond the outer band might also not work.

Candles that close outside of the band but are quite small are not momentum breakout candles. It may however be the continuation of a candle that was supposed to be a momentum breakout but failed to close outside the channel.

Signals that is part of an extended trend might also be something to be cautious about. Momentum trades are based on force. But as a trend becomes to extended, the trends force also gets weakened, and as a result, even some of our signals might not work. The first and second momentum thrust of a trend still have a high probability, but as you go to the fourth thrust and above, it might not have as much force as desired since many of the traders who wanted to get in on that trend might be already in, or worse, have already gotten out.

Also, don’t enter the trade prior to the close of the candle. Until the candle closes, we would never know if the candle is a signal candle for momentum, or it just peaked beyond the outer bands only to retrace back within the channel and close. That leaves you with a candle with a long wick at the other end, which means it is a reversal candle, the exact opposite of the kind of candle that we would want to trade on.

Again, this strategy is a good place to start and develop further. Although signals are clearer for swing trading charts, this could also be effective for scalping given that it is a momentum type of strategy.

Study it, add your own filters, and develop it further. Happy trading.

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