Keltner Channels are volatility-based bands positioned on either side of an asset’s price to help determine the direction of a trend. Utilizing the average true range (ATR), these channels signal potential trend continuations when prices break above or below their barriers.
Key Takeaways
- Understanding Volatility: Keltner Channels are designed to be volatility-based and aid in determining market trends.
- Adjustable Settings: Typically, an exponential moving average (EMA) of 20 periods is used, adjustable to your trading style.
- Bands Calculation: The upper and lower bands are calculated as the EMA plus and minus two times the ATR, respectively. This multiplier can be tweaked for more customization.
- Trend Indicators: Price reaching the upper band indicates a bullish trend, while touching the lower band signifies bearishness.
- Directional Assistance: The angle formed by the Keltner Channels themselves guides traders in detecting the trend direction.
Dive Deep Into Keltner Channels
The Keltner Channel method was initially developed by Chester Keltner in the 1960s. The pioneering formula utilized simple moving averages (SMA) and the high-low price range. In the 1980s, the technique evolved to incorporate the average true range (ATR), which is widely used today.
Essentially, the Keltner Channel is a technical indicator composed of three lines: a middle line calculated as the exponential moving average (EMA) of the price and upper and lower lines positioned two times the ATR above and below it respectively. As volatility changes, the bands will expand and contract.
Since most price movements occur within these bands, price actions outside the bands can forewarn you of potential trend shifts or intensifications.
Leveraging Keltner Channels
Keltner Channels hold various uses depending on how traders set them up. Here’s what traders could look at:
- Trend Identification: A rising channel denotes an uptrend, whereas a falling or flat channel signifies a downtrend or sideways movement.
- Price Strength: An ascent above the upper band reflects a strong price surge underlining an uptrend.
- Price Weakness: A descent below the lower band highlights potential price weakness implying a downtrend.
- Momentum Loss in Trends: Continuously hitting an upper band can indicate weakening uptrend momentum when prices finally dip towards the lower band.
- Terminal Signs of Downtrends: Constantly touching the lower band and then reaching towards the upper band may hint the downtrend is ending.
- Buying and Selling Decisions: Oscillations between upper and lower bands can symbolize support and resistance, useful for timing buys and sells.
- Breakout Signals: Breaking above or below the channel after a sideways period, when coinciding with the direction of channel slope, can signal fresh trends.
Calculating Keltner Channels
To accurately develop a Keltner Channel, perform the following:
- Calculate the EMA over your desired periods, usually 20.
- Determine the ATR over the same or different length periods.
- Multiply the ATR by two then add this to the EMA to get the upper band.
- Subtract the ATR Mulitplier from the EMA to estimate the lower band.
- Continuously repeat after each period ends.
Keltner Channel Upper Band = EMA + (2 × ATR)
Keltner Channel Lower Band = EMA - (2 × ATR)
Keltner Channels vs. Bollinger Bands
Keltner Channels use ATR for computation while Bollinger Bands employ standard deviation. This difference causes variant signal outputs yet similar breakout interpretations, signaling potential trend continuations rather than reversals.
Recognizing Keltner Channel Limitations
The accuracy and effectiveness of Keltner Channels heavily depend on how they are configured. They work best supplemented with other technical indicators and price action analysis rather with standalone usage. There’s no absolute guarantee that the bands function as reliable support or resistance levels intrinsically.
Historic Origin: Chester Keltner
Chester Keltner first conceptualized Keltner Channels in his 1960 book, How to Make Money in Commodities. His work offers valuable foundational insights into modern channel-based trading.
Common Questions
What Is a Keltner Channel Strategy?
If the price breaks above the upper band, consider long positions. Conversely, if the price drops below the lower band, opening short positions is advisable.
Are Keltner Channels Better Than Bollinger Bands?
Keltner Channels and Bollinger Bands each offer unique advantages. Keltner Channels focus on continuation scenarios post breakout, whereas Bollinger Bands might interpret similar movements differently.
What Is the Bottom Line?
Keltner Channels adeptly illustrate trend movements, offer insights on volatilities, and hint at momentum shifts, making them vital yet versatile in a trader’s toolkit.
Related Terms: Bollinger Bands, Exponential Moving Average, Volume Weighted Moving Average, Simple Moving Average.
References
- George Pruitt. “The Ultimate Algorithmic Trading System Toolbox”, Page 69. John Wiley & Sons, 2016.
- Charles Keltner. How To Make Money in Commodities. Keltner Statistical Service, 1960.
