You'll find that a lot of popular trading strategies are variations around a well-established theme.
Trading bands - also known as channels or envelopes - are a case in point.
The core idea is simple.
Even better, it's effective.
The theory in a nutshell is:
Variations tend to revolve around the specifics of where you place the bands.
A volatility channel places the bands an amount away, that is tied to a measure of market volatility.
For example, the distance might be the standard deviation or Average True Range (ATR Indicator).
The Bollinger band is one of the better-known volatility channel methods.
It uses standard deviations as its volatility measure.
If you want to read more about Bollinger bands:
Keltner channels are less well known than Bollinger bands, but they were conceived much earlier.
In fact, the Keltner channel indicator is named after commodity trader Chester Keltner, who first outlined the theory in the 1960s.
In my experience, Keltner channels work just as effectively as any other volatility channel.
This article will discuss how Keltner channels work and how to use them in MT4.
...let's talk a bit more about why volatility channels are useful.
We can very broadly divide traders into two camps:
Both camps are interested in identifying the same things, but for different reasons.
...both want to know if the market is stuck in a range or if it is trending.
But that's just part of the story.
Perhaps even more important is the transition ground between these two conditions.
These are the moments when the direction of the market hangs in the balance.
They are a kind of battleground for rival market forces.
At these levels the market may do one of two things:
After all, it cannot do both.
So how do we work out where these key price points lie?
Well, that's where volatility channels are useful.
They attempt to identify these points of instability.
Crucially, the price of the market is unlikely to remain at these levels for long.
What does that mean for you?
It means you can use the Keltner channel indicator, to easily see levels offering good trading opportunities.
Here's how it works.
The indicator shows three channel lines - upper, lower and central:
...the upper and lower lines help us eyeball these levels of opportunity…
...which leads us to the centreline.
The centreline is:
Typical price is defined as the mean of high, low and close i.e. typical price = (high + low + close)/3
Keltner indicator plots the channel lines relative to the centreline, whereby in Keltner's original version:
But as it turns out, today's Keltner channels are a modified version, which places the channels at the ATR from the centreline.
To complicate matters further, some variations of the indicator use a multiple of ATR.
If these calculations seem a bit fiddly, don't worry:
...it's not too important to know the details...
...as your computer is going to do the number crunching for you.
But understanding the basic nature of what is at play, is critical because it helps you know:
We'll discuss this final point in a bit more detail later in the article.
Read on to find out more.
MetaTrader 4 comes with a comprehensive selection of indicators already installed, but this is just the tip of the iceberg.
There a huge number of custom indicators that you can potentially use, which are developed by users within the vast MT4 community.
Downloading a custom indicator like Keltner channels, involves a few simple steps.
But the good news is:
...after you've downloaded a custom indicator once, you'll find it's the same process each time.
Best of all, it's easy.
You can find the Indicators folder using the File tab in MT4.
Just click on Open Data Folder in the File tab and you'll find the Indicators in the MQL4 folder.
With so many different indicators available, you can create your own bespoke version of MetaTrader 4 in no time.
Or you may prefer to treat yourself to the most advanced version of MT4.
If so, you're best off first checking out the free custom MetaTrader 4 Supreme Edition plugin.
It's worth noting that anytime you add a new indicator, you need to do a restart.
So the Keltner channel download will appear in your indicator list the next time you close and reopen MT4.
From there, you just need to learn how to use it.
The good news is that this is also pretty easy.
Click on Keltner channels in the indicator list.
This gives you a dialogue box which allows you to define the Keltner channel settings.
Now, the default setting is with a time period of 10.
As we saw above, the centreline is a form of moving average (MA).
So, you're setting the timeframe used for this MA.
Just remember that an MA is a lagging indicator, that smooths price:
...so the longer the period…
...the greater the lag and the greater the smoothing.
The period naturally aligns with the timeframe of the chart you are using.
This means that if you are using a daily chart, the averages are calculated for a 10-day period with the default setting.
The version of Keltner channels I used above is pretty simple, but there are more complicated variants out there.
For example, you can find versions that allow you to use:
These are just a few of the different types available.
Ultimately, it's best to use what suits your needs, but the simplest version is a good place to start.
If you cast your mind back to the start of the article - we said that trading strategies using volatility channels, tend to have similarities.
It follows then, that trend-following strategies use volatility channels in a similar way to each other.
This tends to be:
This holds true for trading with Keltner channels.
The chart above shows a daily chart for USD/CHF with 10-day Keltner channels, where the breakout:
It's usually better to use an indicator in combination with another one.
Keltner channels are no different in this regard.
You also want the back-up or confirming indicator, to use a different approach to your primary one.
This also takes us back to something I said earlier.
You need to understand the basic nature of an indicator, to work out how best to combine it with other tools.
Why is this?
It goes to the root cause of why we use indicators in the first place i.e. to identify times that improve our chances of winning.
Sadly, they don't always get it right.
This is where the idea of using a backup or confirming indicator comes in.
We use it to help reduce those pesky times when the indicator spits out a false signal.
If both your prime indicator and your backup indicator use the same approach, you have a problem.
Namely - they are likely to agree with each other no matter what.
So don't use Keltner channels with another volatility breakout indicator for example.
Start by experimenting with what combination works best for you, but to avoid losing real money in the process:
...use a demo trading account for this purpose.
Want to read more about breakout strategies?
Take a look at our guide on the Donchian channel indicator.