Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands.
What is a Keltner Channel?
A Keltner Channel is a volatility based technical indicator composed of three separate lines. The middle line is an exponential moving average of the price. Additional lines are placed above and below the EMA. The upper band is typically set two times the Average True Range above the EMA, and the lower band is typically set 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.
How to Calculate Keltner Channels
- 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 desired multiplier) and then subtract that number from the EMA to get the lower band value.
- Repeat all steps after each period ends.
Interpretation
Indicators based on channels, bands and envelopes are designed to encompass most price action. Therefore, moves above or below the channel lines warrant attention because they are relatively rare. Trends often start with strong moves in one direction or another. A surge above the upper channel line shows extraordinary strength, while a plunge below the lower channel line shows extraordinary weakness. Such strong moves can signal the end of one trend and the beginning of another.
With an exponential moving average as its foundation, Keltner Channels are a trend following indicator. As with moving averages and other trend-following indicators, Keltner Channels lag price action. The direction of the moving average dictates the direction of the channel. In general, a downtrend is present when the channel moves lower, while an uptrend exists when the channel moves higher. The trend is flat when the channel moves sideways.
A channel upturn and break above the upper trend line can signal the start of an uptrend. A channel downturn and break below the lower trend line can signal the start a downtrend. Sometimes a strong trend does not take hold after a channel breakout and prices oscillate between the channel lines. Such trading ranges are marked by a relatively flat moving average. The channel boundaries can then be used to identify overbought and oversold levels for trading purposes.
What Does the Keltner Channel Tell You?
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 ATR. The ATR method is commonly used today.
Keltner Channels have multiple uses. How they are used will largely depend 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.
Users 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 price has been rising, while a falling or sideways channel indicates 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.
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.
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.
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.
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.
The Difference Between a Keltner Channel and Bollinger Bands
These two indicators are quite similar. Keltner Channels use ATR to calculate the upper and bands. Bollinger Bands use standard deviation instead. The interpretation of the indicators is similar, although since the calculations are different the two indicators may provide slightly different information or trade signals.
Limitations of Using Keltner Channels
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 to help accomplish that purpose. Some of the uses of Keltner Channels addressed above, won't work if the bands are too narrow or too far apart.
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.
While Keltner Channels can help identify trend direction, and even provide some trade signals, they are best used in conjunction with price action analysis, fundamentals of trading for the long-term, and other technical indicators.
Conclusion
Keltner Channels are a trend following indicator designed to identify the underlying trend. Trend identification is more than half the battle. The trend can be up, down, or flat. Using the methods described above, traders and investors can identify the trend to establish a trading preference. Bullish trades are favored in an uptrend and bearish trades are favored in a downtrend. A flat trend requires a more nimble approach because prices often peak at the upper channel line and trough at the lower channel line. As with all analysis techniques, Keltner Channels should be used in conjunction with other indicators and analysis. Momentum indicators offer a good complement to the trend-following Keltner Channels.
We look forward to your experiencing the Best Intraday Stock tips or Bank Nifty Option tips and start making money like a professional trader in the Indian stock market and we specialise in these field being the top SEBI Regd Investment advisory service in India.
You
should Trade Less But Trade Accurately & this is Achieved with our Tip.
