Similar channels with subtle differences, how can we use each?
Hey guys, a very good evening to you. Keltner Channels vs Bollinger Bands, what’s the difference, what do they do, how do they work? Well, Keltner channels are based on an average true range. The band is based around an average true range and then a moving average. A Bollinger band is based around a standard deviation, so you get a very different channel effect than you do with Keltners. Bollinger bands, when their volatility expands, they tend to bulge out, as you can see here with something like a Barclays after Brexit.
Keltner’s channels do move out as the price moves but there are a lot smoother, they are based on the range as opposed to the standard deviation which gives them a bit of a smoother thing. I prefer using a Keltner channel. I don’t use it to make trading decisions on solely, but I like to use them just to look how the channels are framing the market. And actually when you look at how they are incorporated in the market, very often, especially on the broader markets, the indices, some of the currency pairs as opposed to individual stocks, they are going to contain price quite often. If you look at some thick stocks like the spiders, like the NASDAQ ETF, very rarely does it touch the outer band, but when it does, you know something is happening, it’s getting interesting. Like times are getting interesting now, hugging that upper band. We dropped to the lower band, things are moving backwards and forwards. When you start to look at the stocks as well, they are a little bit different, the way they behave when they touch Bollinger bands and Keltners. They will tend to burst out a lot more because there’s more individual supply and demand at play than a broad index. But it’s a great filter for getting involved in a trade. If you can scan through and look for something that is touching the upper Bollinger band, lower Bollinger band, upper Keltner, lower Keltner, you can start to really get in tune with that particular stock. Look when Apple gapped down below that Keltner, it was a month or two worth of good action.
But just compare how that is to a Bollinger band, the trouble you’ve got with a Bollinger band is that once you’ve gapped out of it, it takes a while for the bands to contract back up and give you a true reading of what’s going on. Now, often a lot of people like to use Bollinger bands as a signal and rather than using them as a band, so when we touch the upper or lower, is that when they contract and they start to expand again, then you want to trade in the direction of that volatility expansion. So as the bands tighten up, you wait for them to start to expand again and then you trade a break-out in the direction of that move. Like with Apple for example, where they tightened up here as the market starts getting quiet, then they started to expand with this breakout and you would follow that breakout. That is something a lot of traders do use Bollinger bands for.
However, if you look at something like Facebook, they’re really good for earnings. When you see prices gapping out of the band in earnings, and then you’ve got two specific scenarios; you’re either looking for a mean reversion back to the centre band or you’re looking for a price to continue to hug that upper band. Now most of the time in my experience, when price spikes up and touches the upper band, it will revert to the mean at some point. It may not revert fully to the mean in terms of the middle of the Keltner, but it’s going to unwind a little bit as opposed to when price starts to hug the band and it’s a slow grinding, in fact Lecuse are a perfect example of that. When it starts to hug the upper band then it doesn’t become a mean reversion type trade because it’s just showing that there’s a lot of strength going on and it’s grinding upwards as opposed to spiking. So the difference – when the price spikes the band, it’s a bit more likely to mean revert, potentially in the short term for one or two days, not necessarily for long term. We can see here, NASDAQ, we did spike here, then we did go lower but you can see how much choppier that trade is and there’s definitely two way trade to be had on an intraday basis, whereas if we’re touching the upper band and we’re just grinding up against it, you’re struggling to get much short action intraday on that because it’s not going to give you much of a pull back. So, that’s just something to be aware of and just one way of looking at them.
Loads of other ways of using them out there but just an introduction to them. I know we have talked about these a bit before. I prefer to use the Keltners, but it’s a personal preference and they can be a nice useful tool just to frame your trade and get an idea of where you are because you may not want one specific filter, something you may not want to do is chase a market that’s outside of its Keltner channel, that could just be a very simple filter to stop you getting into trouble.
Anyway, take care guys, back same time tomorrow.