Keltner Channel Indicator
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Keltner Channels are volatility-based bands used in technical analysis that are placed on either side of an asset’s price.
They can aid in determining the direction of a trend.
The Keltner Channel uses the average true range (ATR) or volatility.
Breaks above or below the top and bottom barriers signal a continuation.
Understanding the Keltner Channel
The Keltner Channel was first introduced by Chester Keltner in the 1960s.
The original formula used simple moving averages (SMA) and the high-low price range to calculate the bands.
In the 1980s, a new formula was introduced that used average true range (ATR).
The ATR method is commonly used today.
The Keltner Channel is a volatility-based technical indicator composed of three separate lines.
The middle line is an exponential moving average (EMA) of the price.
Additional lines are placed above and below the EMA.
The upper band is typically set two times the ATR above the EMA.
The lower band is typically set at the inverse of two times the ATR (below the EMA).
The bands expand and contract as volatility (measured by ATR) expands and contracts.
Since most price action will be encompassed within the upper and lower bands (the channel), moves outside the channel can signal trend changes or an acceleration of the trend.
The direction of the channel, such as up, down, or sideways, can also aid in identifying the trend direction of the asset.
Using Keltner Channels
Keltner Channels have multiple uses.
How they are used largely depends on the settings a trader uses.
A longer EMA will mean more lag in the indicator, so the channels won’t respond as quickly to price changes.
A shorter EMA will mean the bands react quickly to price changes but will make it harder to identify the true trend direction.
A bigger multiplier of the ATR to create the bands will mean a larger channel.
The price will hit the bands less often.
A smaller multiplier means the bands will be closer together, and the price will reach or exceed the bands more often.
Traders can set up their Keltner Channels any way they like, with the following potential uses in mind:
The angle of the channel helps to identify trend direction.
A rising channel means the price has been rising, while a falling or sideways channel indicates the price has been falling or moving sideways, respectively.
A price move above the upper band shows price strength.
This is another indication that an uptrend is in play, especially if the channel is angled upwards.
A drop below the lower band shows price weakness.
This is evidence of a downtrend, especially if the channel is angled downward.
It can signal that an uptrend is losing momentum.
If the price is continually hitting the upper band but not the lower, when the price does finally reach the lower band, it could be a sign that the uptrend is losing momentum.
It can signal that a downtrend is near its end.
If the price is constantly hitting the lower band but not the upper, when the price does finally reach the upper band, it could be a signal that the downtrend is near an end.
It can be a buying and selling indicator.
The price may also oscillate between the upper and lower bands.
In cases like these, traders may use the bands as support and resistance.
They may look to buy when the price reaches the lower band and then starts to move higher again.
They may look to sell or short after the price starts to fall again after reaching the upper band.
As a price breakout indicator.
After a sideways period, if the price breaks above or below the channel and the channel starts to angle the same way, that may signal that a new trend is underway in that breakout direction.
Keltner Channel Calculation
Keltner Channel Middle Line = EMA
Keltner Channel Upper Band = EMA + 2 ∗ ATR
Keltner Channel Lower Band = EMA − 2 ∗ ATR
Where:
EMA = Exponential moving average (typically over 20 periods)
ATR = Average True Range (typically over 10 or 20 periods)
Steps to Calculate Your Keltner Channel
- Calculate the EMA for the asset, based on the last 20 periods or the number of periods desired.
- Calculate the ATR of the asset, based on the last 20 periods or the number of periods desired.
- Multiply the ATR by two (or the multiplier desired) and then add that number to the EMA value to get the upper band value.
- Multiply the ATR by two (or the desired multiplier) and subtract that number from the EMA to get the lower band value.
- Repeat all steps after each period ends.
Keltner Channels vs. Bollinger Bands
Keltner Channels use ATR to calculate the upper and lower bands.
Bollinger Bands use standard deviation.
The interpretation of the indicators is similar, although since the calculations are different, the two indicators may provide slightly different information or trade signals.
This indicator is most useful in strongly trending markets when the price is making higher highs and higher lows for an uptrend, or lower highs and lower lows for a downtrend.
Keltner Channel Limitations
The usefulness of the Keltner Channels largely depends on the settings used.
Traders first need to decide how they want to use the indicator and then set it up.
Some of the uses of Keltner Channels, addressed above, won’t work if the bands are too narrow or far apart.
While Keltner Channels can help identify trend direction and even provide some trade signals, they are best used in conjunction with price action analysis, other technical indicators, and fundamentals if trading for the long term.
The bands may also not act as support or resistance, and they may seem to have little forecasting ability at all.
This could be due to the settings chosen, but there is also no evidence that the price moving two ATRs or hitting one of the bands will result in a trading opportunity or something significant happening.
Who Was Chester Keltner?
Chester Keltner was a market technician who originally developed Keltner Channels in his 1960 book, How to Make Money in Commodities.
What Is the Keltner Channel Used For?
The Keltner Channel is used to identify trade opportunities in swing action as prices move within an upper and lower band.
What Is the Difference Between the Keltner Channel and Bollinger Bands?
Both technical indicators are similar.
However, the Keltner Channel utilizes average true range (ATR) while Bollinger Bands use standard deviation.
Are Keltner Channels or Bollinger Bands a Better Metric?
Both metrics are useful but produce different signals.
Like Bollinger Bands, Keltner Channel signals are produced when the price action breaks above or below the channel bands.
Here, however, as the price action breaks above or below the top and bottom barriers, a continuation is favored over a retracement back to the median or opposite barrier.
What Is a Keltner Channel Strategy?
If the price action breaks above the band, the trader should consider initiating long positions while liquidating short positions.
If the price action breaks below the band, the trader should consider initiating short positions while exiting long or buy positions.
Concluding Thoughts
A Keltner Channel is a trading indicator that tracks volatility using an asset’s exponential moving average and average true range.
Traders use it to identify trend directions, possible reversals, and price strengths and weaknesses.
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