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 (EMA) of the price. Additional lines are placed above and below the EMA. The upper band is typically set two times the Average True Range (ATR) above the EMA, and 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.
- The EMA of a Keltner Channel is typically 20 periods, although this can be adjusted if desired.
- The upper and lower bands are typically set two times the ATR above and below the EMA, although the multiplier can also be adjusted based on personal preference. A larger multiplier will result in a wider channel.
- Price reaching the upper band is bullish, while reaching the lower band is bearish. Reaching a band may indicate a continued trend in that direction.
- The angle of the channel also aids in identifying the trend direction. When the channel is angled upwards, the price is rising. When the channel is angled downward the price is falling. If the channel is moving sideways, the price has been as well.
- The price may also oscillate between the upper and lower bands. When this happens, the upper band is viewed as resistance and the lower band is support.
The Formula for a Keltner Channel is
Keltner Channel Middle Line=EMAKeltner Channel Upper Band=EMA+2∗ATRKeltner Channel Lower Band=EMA−2∗ATRwhere:EMA=Exponential moving average (typically over 20 periods)
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.
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 if trading for the long-term, and other technical indicators.