The Keltner Channel is named after Chester W. Keltner, an American cereal trader who described it in his 1960 book “How to Make Money in Commodities.” Keltner initially referred to it as a ten-day Moving Average, with the centerline representing the typical price.
The lines above and below the centerline were drawn at a distance, with the distance being the Simple Moving Average of the trading ranges for the previous ten days. Linda Bradford Raschke modified the Keltner Channel by adding multiple averaging periods, an Exponential Moving Average, and the Average True Range (ATR) for the bands.
Definition
Keltner Channels are a combination of the Exponential Moving Average and the Average True Range. The ATR lines are drawn twice on the upper band (above the EMA) and two times on the lower band (below the EMA).
Application of Keltner Channels on a chart
There are a few factors you can modify while using the indicator on your chart. The first is the number of periods the indicator should look at. The Moving Average default settings are 20-day and have a multiplier of 1 regardless of whether they are daily charts, weekly charts, or monthly.
This can be adjusted if you want to change. Then, we must select an ATR Multiplier. The numbers 2 and 3 are all common. The upper and lower bands will be 2 or 3 Average True Range measures apart from the Moving Average, respectively. These, too, can be adjusted in the settings.
Formulae for calculating
Let’s look at the formula for calculating Keltner Channel.
Keltner Channel Middle Line = EMA
Keltner Channel Upper Band = EMA +2 * ATR
Keltner Channel Lowe Band = EMA – 2 * ATR
Where:
- EMA = Exponential Moving Average (typically over 20 periods)
- ATR = Average True Range (typically over 10 or 20 periods)
- 2 = Multiplier
Calculation steps
- Before computing the EMA, choose the asset’s length, which is normally 20 periods but can be changed.
- After the number of periods has been chosen, calculate the Average True Range (ATR).
- For the ATR, select a multiplier. This is normally two, although it can be changed if necessary.
- To obtain the upper band’s value, multiply the ATR by the multiplier (usually two) and then add the result to the EMA.
- To find the value of the lower band, multiply the ATR by the desired multiplier (typically two) and subtract the value from the EMA.
Signals interpretation
- Price Breaking Above the Upper Band: If the price breaks above the upper band, it could indicate the start of an uptrend.
- Below the Lower Band: If the price falls below the lower band, it could suggest the start of a downturn.
- If the price falls between the middle line and the upper band, it could indicate that the price is range-bound. You can expect a reversal or a breakthrough from the upper band in such cases.
- Between the Middle Line and the Lower Band: If the price falls between the middle line and the lower band, you can deduce that the price is range-bound, as in the previous example. In this instance, you’d expect the lower band to bounce or break out.
Trading strategies
Breakout strategy
The Breakout Trading Strategy is prompted when the actual price crosses over one of the outer bands of the channel, suggesting an impending change in trend. A cross above the middle line can also be used to suggest a breakout if the price action was lingering between the middle line and an outer band. It can also happen if a price candlestick falls totally outside of the channel or if the close price is required to be outside of the channel.
In the USDJPY chart above, price area A shows the candlestick crossing over below the lower band. It followed a trend reversal.
Overbought and oversold strategy
It is easy to use the indicator channels to determine if the price is oversold or overbought. When price movement is consistently outside of the channel or hanging about an outer band while the trend is flat, the asset is in an overbought or oversold position, prompting a trade. The price candlesticks will linger outside of the channel for a long time in this case.
An oversold condition occurs when the price stays outside the lower band of the indicator for an extended period of time. When the price stays outside the top band of the channel for a while, it indicates that the market is overbought.
In the GBPJPY chart above, the candlesticks were constantly staying outside the lower band. This means the GBPJPY was oversold.
Bollinger squeeze strategy
Bollinger Bands are quicker than Keltner Channels at responding to changes in market volatility. As a result, when an asset’s price fluctuation is suddenly reduced, the Bollinger Bands shrink and totally submerge within the Keltner Channels for several trading sessions. A squeeze is a name for this pattern. As a result, when the Bollinger Bands are totally inside the Keltner Channel, the squeeze occurs.
The squeeze, in theory, denotes a period of little price variation and low market activity. While this may appear to be a benign formation, it actually indicates an oncoming change in volatility. This is due to the fact that a flat trend is unusual.
Traders may be frightened of the flat trend and exit the asset or increase demand because they believe the asset is undervalued. As a result, by combining both of these indicators, the Bollinger Bands, and the Keltner Channels, you can confirm a significant decrease in volatility, which in turn clearly suggests a likely rally or dip.
Conclusion
In conclusion, Keltner Channels are volatility-based envelopes that are set above and below an Exponential Moving Average. They can be calculated, and many charting applications have default settings. The indicator can be used to determine oversold or overbought conditions and identify breakouts. Bollinger Bands is helpful to determine volatility and trade breakouts.