Keltner Channel

The Keltner Channel is a volatility-based market indicator that combines two outer bands, representing the average true range (ATR) of an asset's prices, with a central band that follows a twenty-period exponential moving average (EMA) of the asset's price. Traders use this indicator to identify trends, recognize oversold and overbought conditions, and generate trading signals.

It is also valuable for predicting potential trend reversals and breakouts. A breakout above the upper band is considered a bullish signal, while a breakout below the lower band is seen as a bearish indicator. However, the effectiveness of the Keltner Channel depends on the settings used; bands that are too far apart or too narrow may not yield the desired results.

• The Keltner Channel is a market indicator combining an asset's average true range (ATR) and a twenty-period exponential moving average (EMA) to create two outer and central bands.
• This indicator is commonly used to identify trends, oversold and overbought conditions, and generate trading signals. Traders also use it to anticipate potential trend reversals and breakouts.
• It uses ATR for calculating the bands, whereas Bollinger bands use standard deviation for calculating the bands.
• To compute the Keltner Channels, the following equation should be employed:
  • Middle Line: 20-period exponential moving average
  • Upper Channel Line: 20-period EMA plus (2 multiplied by the 10-day ATR)
  • Lower Channel Line: 20-period EMA minus (2 multiplied by the 10-day ATR)

The Keltner Channel strategy is a trend-following indicator that identifies reversals, channel direction, and breakouts. Day traders often employ this volatility-based technical indicator to assess existing trends and receive trading signals. The Keltner Channel is constructed using three lines that move with the price to create channels. These channels are formed by the lower, upper, and middle lines, which utilize volatility and average prices to calculate the Keltner channels.

Chester Keltner developed the Keltner Channel in 1960 by combining the average true range (ATR) and the exponential moving average (EMA). The underlying concept of the Keltner Channel is that assets tend to stay within a certain range, with occasional price breaches that signify the beginning of a new trend. The indicator comprises three lines: a central moving average line (based on a typical 20-period EMA of the security price) and two external lines (based on the asset's ATR to measure its volatility). The upper outer line extends at a double ATR value above the central line, while the lower outer line extends at a double ATR value below the central line.

Traders utilize the Keltner channel in various ways to profit from assets, as outlined below:

• Selling assets when the price breaches the upper line, indicating the asset has been overbought.
• Buying assets when the price breaches the lower line, indicating the asset has been oversold.

In addition, if the asset price remains within the channel, traders can expect the asset to trade within that range, enabling them to buy low and sell high as the asset oscillates within the channel's boundaries.

Using the Keltner channel involves the following steps:

Set up the Keltner channel indicator, customizing parameters like EMA and ATR periods.

• Identify the trend direction based on the price's position relative to the middle line (20-day EMA).
• Spot potential overbought and oversold conditions when the price touches or moves outside the upper or lower channel lines.
• Look for breakout opportunities when the price moves above the upper line (bullish) or below the lower line (bearish).
• Combine the Keltner channel with other indicators or strategies for enhanced effectiveness.
• Implement risk management techniques, setting stop-loss and take-profit levels to protect capital.
• Test and refine the strategy using historical data or a demo account to optimize performance under different market conditions.

Chart

Let us look at the Keltner channel chart below to understand the concept better.

Source

In the Ethereum/Tether chart, we can find that the rising upper channel between 12 pm and around 5 pm on February 15, 2023, signals an increase in price. On the other hand, the sideways or falling channel the next day shows that the price moves sideways before dropping.

The price move over the channel on February 15, 2023, shows the strength of the price. Moreover, it is an indication that an upward trend is in play. On February 16, 2023, one can observe a slightly downward angle of the lower channel, with the price reaching it. This indicates that the upward trend is losing its momentum.

For more such charts concerning the Keltner channel indicator, one can consider visiting TradingView.

Let's look into a few examples to understand the concept better:

Example #1

The Yes Bank stock experienced a significant decline, starting from ₹404 in August 2018. During its downward movement, the stock breached the Keltner channels on the downside and reached a low of ₹5.55 in March 2020. However, the stock recovered from its lows and reached a high of ₹20.83 in December 2020.

Subsequently, from March 2021 to November 2022, the stock's price remained within a trading range of ₹10 to ₹18. This period can be characterized as a consolidation phase, where the stock did not experience significant price movements. Overall, the stock underwent a volatile journey, facing a major decline, followed by a recovery phase, and later entering a consolidation period.

Imagine a trader has been following the stock of a company, XYZ Inc. The stock has been trading around an average price of $50 (forms the middle line of the Keltner channel) over the past few weeks.

The trader notices that the stock's price tends to fluctuate. So he decides to set a price range around the average. He sets the upper channel line at $55 (the middle line + $5). Then he sets the lower channel line at $45 (the middle line - $5).

Now, with the Keltner Channel in place, the trader can use it to guide their trading decisions:

• Trend Direction: As long as the stock's price stays within the Keltner Channel's boundaries (between $45 and $55), the stock is in a stable trading range, and there is no clear indication of a strong uptrend or downtrend.
• Overbought and Oversold Conditions: If the stock's price approaches the upper channel line or goes above it (e.g., $57), it might suggest the stock is overbought, meaning it could be getting too expensive, and there may be potential for a price pullback.
• Breakouts: Suppose the stock's price breaks above the upper channel line (e.g., $60). This could be a signal that the stock is experiencing a bullish breakout, indicating potential strength in the upward trend. Traders might consider buying the stock, expecting further price increases.
• Reversals: If the stock's price drops below the lower channel line (e.g., $42), it might indicate an oversold condition, meaning the stock is becoming too cheap, and there may be potential for a price bounce or trend reversal to the upside.

The Keltner channel helps gauge the stock's price movement and make informed decisions based on its position relative to the channel lines.

The main differences between the Keltner Channel and Bollinger bands are the following:

This article has been a guide to what is Keltner channel. Here, we compare it with Bollinger bands and explain how to use it along with examples. You may also find some useful articles here -

• Donchian Channel
• Momentum Trading
• Trading Strategy