Indicator Insights Part 5: Super-Wide Keltner Channels
In the final part of our Indicator Insights series, we explore Keltner Channels, particularly their application in identifying mean reversion opportunities known as 'snapbacks.' We reveal modified Keltner Channel settings that can help active day traders identify short-term turning points, we look at the advantages of this approach, and run through several real-world examples.
Understanding Keltner Channels:
Keltner Channels are a volatility-based indicator composed of three lines – the middle line representing the Exponential Moving Average (EMA) of price, and upper and lower bands calculated using the ATR. Unlike traditional Bollinger Bands, Keltner Channels use Average True Range (ATR) ATR, making them adaptable to varying market conditions and suitable for comparing different markets.
Standard Settings:
The standard settings for Keltner Channels involve a 20-period EMA and a multiplier of 2 for ATR. This configuration is effective for capturing trends and identifying potential reversals. However, on lower timeframes like the five-minute candle chart, these settings might produce an abundance of false signals.
EUR/USD 5min Candle Chart: Keltner Channels Standard Settings
Past performance is not a reliable indicator of future results
Snapbacks and Adjustments:
Snapbacks, or mean reversion opportunities, occur when price extends beyond the Keltner Channels and quickly 'snaps back' within them. To address the increased false signals on lower timeframes, traders can adjust the settings by increasing the moving average period, flattening the bands, and raising the ATR multiplier, widening the bands.
Super-Wide Keltner Channels:
Day traders using the five-minute chart could potentially benefit from 'super-wide' Keltner Channels, set with a 60-period moving average and a 6 ATR multiplier. These broader, and flatter bands are designed to identify significant price movements and distinguish meaningful mean reversion signals from transient market noise.
EUR/USD 5min Candle Chart: Standard Versus Super-Wide Keltner Channels
Past performance is not a reliable indicator of future results
Advantages of Super-Wide Keltner Channels:
Reduced False Signals: By flattening the bands with the increased period and widening them with a higher ATR multiplier, super-wide Keltner Channels filter out minor fluctuations, offering more robust signals.
Enhanced Mean Reversion Signals: Snapbacks identified using super-wide channels tend to be more meaningful, indicating substantial deviations from the norm and higher potential for mean reversion. For example, should prices tough the upper band of a super-wide Keltner Channel, this means that price has moved more than six times away from its mean.
Worked Examples:
EUR/USD
In this example, EUR/USD moves down to touch the lower super-wide Keltner Channel on the 5-min candle chart. With prices now more than 6 ATR extended from the mean on this timeframe, EUR/USD snaps back to the mean. This example also shows prices pushing into the upper Keltner Channel and reverting back to the mean.
EUR/USD 5min Candle Chart
Past performance is not a reliable indicator of future results
Apple (AAPL)
In this example, Apple’s share price presses down into the lower super-wide Keltner Channel. Notice how price forms a double bottom reversal pattern before reverting back to the mean. Combining price patterns with technical indicators in this way can help to improve timing and accuracy of trades.
AAPL 5min Candle Chart
Past performance is not a reliable indicator of future results
Complementary Indicators:
To further refine the strategy, traders can incorporate complementary indicators such as Relative Strength Index (RSI) divergence and previous day's high and low. RSI divergence helps to confirm overbought or oversold conditions, while the previous day's levels provide additional context for potential intra-day reversals.
Example: EUR/USD 5min Candle Chart
In this example, we can see that as price moves into the lower super-wide Keltner channel, the RSI starts to form a higher low – signalling bullish divergence. EUR/USD then climbs back above the previous day’s low (PDL) – adding conviction to the trade.
EUR/USD 5min Candle Chart
Past performance is not a reliable indicator of future results
Summary:
Super-wide Keltner Channels, tailored for day traders on a five-minute chart, offer a different approach to identifying and capitalising on potential mean reversion opportunities. By adjusting the moving average period and ATR multiplier, traders can fine-tune the indicator for their specific timeframe and tolerance, reducing false signals and enhancing the significance of mean reversion signals.
Disclaimer: This is for information and learning purposes only. The information provided does not constitute investment advice nor take into account the individual financial circumstances or objectives of any investor. Any information that may be provided relating to past performance is not a reliable indicator of future results or performance. Social media channels are not relevant for UK residents.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 84.01% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Understanding Keltner Channels:
Keltner Channels are a volatility-based indicator composed of three lines – the middle line representing the Exponential Moving Average (EMA) of price, and upper and lower bands calculated using the ATR. Unlike traditional Bollinger Bands, Keltner Channels use Average True Range (ATR) ATR, making them adaptable to varying market conditions and suitable for comparing different markets.
Standard Settings:
The standard settings for Keltner Channels involve a 20-period EMA and a multiplier of 2 for ATR. This configuration is effective for capturing trends and identifying potential reversals. However, on lower timeframes like the five-minute candle chart, these settings might produce an abundance of false signals.
EUR/USD 5min Candle Chart: Keltner Channels Standard Settings
Snapbacks and Adjustments:
Snapbacks, or mean reversion opportunities, occur when price extends beyond the Keltner Channels and quickly 'snaps back' within them. To address the increased false signals on lower timeframes, traders can adjust the settings by increasing the moving average period, flattening the bands, and raising the ATR multiplier, widening the bands.
Super-Wide Keltner Channels:
Day traders using the five-minute chart could potentially benefit from 'super-wide' Keltner Channels, set with a 60-period moving average and a 6 ATR multiplier. These broader, and flatter bands are designed to identify significant price movements and distinguish meaningful mean reversion signals from transient market noise.
EUR/USD 5min Candle Chart: Standard Versus Super-Wide Keltner Channels
Advantages of Super-Wide Keltner Channels:
Reduced False Signals: By flattening the bands with the increased period and widening them with a higher ATR multiplier, super-wide Keltner Channels filter out minor fluctuations, offering more robust signals.
Enhanced Mean Reversion Signals: Snapbacks identified using super-wide channels tend to be more meaningful, indicating substantial deviations from the norm and higher potential for mean reversion. For example, should prices tough the upper band of a super-wide Keltner Channel, this means that price has moved more than six times away from its mean.
Worked Examples:
EUR/USD
In this example, EUR/USD moves down to touch the lower super-wide Keltner Channel on the 5-min candle chart. With prices now more than 6 ATR extended from the mean on this timeframe, EUR/USD snaps back to the mean. This example also shows prices pushing into the upper Keltner Channel and reverting back to the mean.
EUR/USD 5min Candle Chart
Apple (AAPL)
In this example, Apple’s share price presses down into the lower super-wide Keltner Channel. Notice how price forms a double bottom reversal pattern before reverting back to the mean. Combining price patterns with technical indicators in this way can help to improve timing and accuracy of trades.
AAPL 5min Candle Chart
Complementary Indicators:
To further refine the strategy, traders can incorporate complementary indicators such as Relative Strength Index (RSI) divergence and previous day's high and low. RSI divergence helps to confirm overbought or oversold conditions, while the previous day's levels provide additional context for potential intra-day reversals.
Example: EUR/USD 5min Candle Chart
In this example, we can see that as price moves into the lower super-wide Keltner channel, the RSI starts to form a higher low – signalling bullish divergence. EUR/USD then climbs back above the previous day’s low (PDL) – adding conviction to the trade.
EUR/USD 5min Candle Chart
Summary:
Super-wide Keltner Channels, tailored for day traders on a five-minute chart, offer a different approach to identifying and capitalising on potential mean reversion opportunities. By adjusting the moving average period and ATR multiplier, traders can fine-tune the indicator for their specific timeframe and tolerance, reducing false signals and enhancing the significance of mean reversion signals.
Disclaimer: This is for information and learning purposes only. The information provided does not constitute investment advice nor take into account the individual financial circumstances or objectives of any investor. Any information that may be provided relating to past performance is not a reliable indicator of future results or performance. Social media channels are not relevant for UK residents.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 84.01% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.