A trading tips blog reader sent me a question about the Keltner Channel trading strategy article that I put together. If you have not read that article, I suggest you go back and take a look through it so what you are about to read makes sense.
In truth, I can’t give an absolute number because there are no absolutes in trading. Yes, we hear that trading the first pullback is usually the best but I’ve never seen any statistics to back that up.
So what do we do?
What I will say is that any excursion to and beyond the channel is the trading setup regardless of how many times it does that. That’s part of the trading strategy and unless price action is showing an exhaustion move that may put us in a holding pattern, we take the trade.
Sometimes price won’t reach the channel for some reason (such as an extreme price movement prior) so does the invalidate any trade that pulls back towards the 20 EMA?
To answer that, we go back to the basics to understand what we are looking for to point us towards another possible pullback trade.
It’s All About The Impulse Leg In The Swing
What the Keltner Channel does is simply show us an extreme movement in the impulse leg when price touches/exceeds either of the outer channel lines. We ask ourselves “does that impulse move deserve another trade in its direction? The answer, assuming we are not looking at an exhaustion pattern, is yes.
The Keltner Channel gives us an objective measure of the impulse leg but what happens if price does not reach the channel extreme? Are all other trades off the table even if we get a trade back inside to the area of the moving average.
We just have to employ a little subjectivity into the trading equation. We must employ some swing analysis as well as watch the unfolding price action that may indicate another impulse leg.
Have More Than One Trade Setup
If you have one trade setup that use over and over again, you are ahead of many in this game. From my experience and the interactions I have with people looking to trade and with “traders”, having a clear cut setup is not commonplace.
The experience we have as traders at Netpicks taught us that having more than one way to get into a trade is the right thing. Our trading systems have several setups you can employ that enables you to take advantage of the price moves in the market.
The same is true with the Keltner Channel strategy.
This is a daily chart of a Forex pair that helps explain alternate methods for trading a pullback and the reasons why. Again, there is subjectivity involved but the explanations all fit standard trading practice.
Price has actually came off a down trend and price broke, with momentum, the trend line that outlined resistance. A common occurrence with trend line breaks is break-retest. Even though we don’t see any excursion beyond the channel in this example, price breaks the trend line and comes back to retest in the area of the 20 EMA.
No excursion but price breaks the highs on the left with a candlestick that shows momentum. We see a strong thrust against price but then price simply consolidates over the next two days just below the former resistance that may be turning into support. Basing just under resistance is a bullish sign and the slowing price action allows the 20 EMA to catch up to price.
Momentum candlestick drives price through the channel for the first time in this developing trend change. which indicates the party for the bears is done. Easy pullback to the zone of the 20 EMA then a strong thrust to the upside.
Price is outside the channel which can signify a little extra juice in the market. This often times can lead to stronger than “normal” retrace. Price pulls back to retest breakout zone and the 20 EMA zone.
Price is trending outside the channel and this current uptrend goes out with a whimper instead of a bang. You could wait to see what price does around the 20 EMA but you can see that unlike the other setups, there is no obvious sign of bullish intent.
Remember Rule Of Alternation During Pullbacks
When traders look at price action trading, one place they can get confused is during a pullback. Since an uptrend is a series of higher highs and higher lows, when that starts to change, you may start to question the current trend as price rips by the 20 EMA
Don’t do that.
Price generally corrects in an alternating pattern of complex and simple corrections. You may see price breach the channel and then swing right by the moving average and then put in a lower high in an uptrend example.
This does not mean the trend is dead.
Certainly not the best example but you can see that price broke the upper channel with momentum and stayed outside the channel for several days.
Price consolidates although not long enough to work off the large move and begins another retrace. This is where many traders will look to short.
- While price did have an extreme move relative to previous action, the several day consolidation takes the concern of an exhaustion move off the table.
- Price had been putting in a more macro higher high and higher low sequence. I am ignoring the moving average slope due to the sudden burst in price movement.
- Price bottoms out at 100% of the prior swing which many call symmetry in price movement
In this example, we combined our trading setup with price action to still be able to get into a trade in the direction of the trend. It’s clear others had a contrarian opinion but were quickly brought back into reality.
Trade The Trend Until It Ends
I could have simply answered that taking each pullback until one fails is a way to trade pullbacks. That would have then opened a question about how you can still trade pullbacks even without the excursion.
The move outside the channel is a quick scanning tool as well as an objective measure of impulse leg strength. For those needing a more mechanical approach they can certainly stick to trading that setup.
But the markets offer us so much more over the trading year and finding ways to capitalize on them, without over trading, is just another part of being a trader.
Take a look at how to trade other indicators with the free Technical Indicator Blueprint. Download here.
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