Discovering Keltner Channels and the Chaikin Oscillator

After students of technical analysis master some of the foundational indicators, they might want to tackle some of the lesser-known and discussed technical indicators. Here we take a look at Keltner Channels and the Chaikin Oscillator which are not without a devout following.

Keltner Channels

Chester W. Keltner introduced and developed the Keltner Channels in his book "How To Make Money in Commodities" (1960). Like Bollinger Bands®, Keltner Channels are simply moving-average bands. (See The Basics of Bollinger Bands®.) Moving-average bands and channels are the same thing: a middle line and two outer lines.

Keltner Channels represent the average of the high, low and the closing price of an issue. On each side of the middle line are bands that are formed from the daily high minus the daily low over a period of 10 days. Technicians believe the theory that the price of an issue is most likely to trade within the boundaries of bands or envelopes. The trader is to sell the issue when the closing price exceeds the upper band and to buy the issue when the closing price falls outside the lower band. This theory is probably best explained in Perry Kaufman's book entitled "The New Commodity Trading System and Methods".

Chart Created with Tradestation

You can see in the above chart of Sun Microsystems, Inc. that on many occasions from Jul 2002 to Feb 2003 the theory that states the stock should be traded when the closing price falls outside the envelopes on either side of the middle line holds true. Arrows indicate a few examples of this happening. You can plainly see that the sell signals are far clearer than the buy signals, so I strongly suggest that all investors add two or three other indicators to their charts to confirm a buy/sell signal of any issue they may be following. (Learn more, in Using Bollinger Band "Bands" To Gauge Trends.)

Chaikin Oscillator
Developed by Marc Chaikin, the Chaikin Oscillator is one of the more interesting of the lesser-knowns. The Chaikin Oscillator monitors the flow of money in and out of the market. It calculates and plots the difference between the 10-period exponential moving average and the three-period exponential moving average of the accumulation distribution. The accumulation distribution uses the relationship between the open and the close of the bar and the range of the bar to weigh and characterize the volume as accumulation (buying) or distribution (selling).

The Chaikin Oscillator simply compares the money flow to the price action of an issue, which in turn allows the chartist to recognize tops and bottoms in short cycles. Marc Chaikin suggests that his indicator be implemented in conjunction with a 21-day envelope based on the price of the issue. Price envelopes are plotted at a set percentage above and below a moving average. They are used to indicate overbought and oversold levels.

Chart Created with Tradestation

The chart above displaying JDS Uniphase from Jul 2002 to Feb 2003 shows arrows that walk you through interpreting the oscillator. First off, the 20-day price channels on top of the price action allow you to follow the overbought and oversold positions of this chart. It is very easy to see why many technicians would look closely at the Chaikin Oscillator when deciding whether or not to jump in or out of an issue. The first red arrow (down) on Aug 27 clearly shows an overbought position and a subsequent sell-off, which sends the stock price down from the $3.50 level to $1.50 before the turnaround takes place on or about Oct 10. The first blue arrow (up) indicates the end of the oversold position of the issue. The other two arrows are just as clear in indicating how timely this combination of Price Channels and the Chaikin Oscillator is.

Remember it's your money - invest it wisely. (For more, read Moving Average Envelopes: Refining A Popular Trading Tool.)