Keltner Channels

Introduction

The world of stocks is seldom a stable one with fluctuations tending to be rampant. If you’re a newcomer to the landscape feeling overwhelmed by it all is a pretty common emotion. Even the pros can experience that if things move beyond their control which there’s always a chance of.

Navigating among all that noise can be difficult if you have nothing at your disposal in the  way of tools or indicators. Trying to make any kind of sense out of things within this landscape is therefore a priority that no sensible trader would ignore and employing the help of indicators towards that end would be a good start.

As far as indicators are concerned there are many for you to choose from including SMAs, EMAs, WMAs, and many more. However the  indicator that we’ll be covering here instead is the Keltner Channels.

What are Keltner Channels?

Keltner Channels were first introduced way back in the 1960s by Chester Keltner so you can see where the name comes from now! But the original formula interestingly enough used SMAs or simple moving averages alongside the high and low price range to calculate those bands.

But in the 1980s things could a different turn with the introduction of a new formula which used the ATR or average true range and that is a very commonly used method in these times.

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The Purpose of Keltner Channels

The Keltner Channel is basically a volatility-based technical indicator that comprises three separate lines including the middle line, the upper and lower bands.

The middle line is just an EMA or exponential moving average of the price with those additional lines being placed below and above it.

The upper band is usually set two times that ATR over the EMA with the lower band being set at the inverse of twice the ATR below that EMA. These bands contract and expand as volatility which the ATR measures expands and contracts.

As most price action tends to be encompassed inside the lower and upper bands, aka the channel, any move outside that could potentially signal trend changes or even an acceleration of that specific trend.

That channel’s direction whether its up or down or even sideways may in turn aid in determining the direction that the asset is trending towards

How are Keltner Channels Calculated?

WHile you wont have to calculate the Keltner Channels on your own considering how most trading platforms that support it will automatically do it for you, if you happen to be more of a curious type then it certainly wont hurt knowing what goes in its calculations to have a better idea of how it works. So in case you are read on then.

Keltner Channel Calculation Steps

The first step would be to determine how many periods you want there to be and that would more or less depend on your trading style. 20 periods appear to be standard but if you want something else then you can always change that obviously.

After that find out the EMA for your asset based on the number of periods that you’ve selected and do the exact same for the asset’s ATR.

Once that’s done multiply that ATR by two or whatever multiplier you want and then add that result you get to that EMA and there you have it! The upper band’s value!

To get that lower band’s value you have to do the exact opposite of the upper band’s calculation by multiplying that ATR by two once more only to then subtract that result from the EMA this time.

Finally repeat all of these steps after the end of every period.

Key Characteristics of Keltner Channels

The key components or rather characteristics of the Keltner Channels at least based from what we’ve stated so far happen to be the ATR, those upper and lower bands, and finally the middle line which is essentially the EMA.

How to Use Keltner Channels in Trading

By now you must have a fair idea of what this indicator is supposed to be but how can you use it in trading now? After all knowing something is one thing and actively using it is another so let’s find out.

Trend Identification

The most obvious way to use it in trading would be to identify whether or not a trend is actually occuring or which direction is it currently heading towards.  And with that the angle of that channel can help determine all that.

You see if there’s a rising channel then it means that price is increasing whereas a sideways or falling channel shows the opposite that the price has been moving sideways or is falling.

Overbought and Oversold Conditions

The next thing it’s good for is finding out whether there are overbought or oversold conditions inside the market. For example if you see the price continually hitting that upper band then it could mean that there are overbought conditions and when that price does eventually reach that lower band then it could indicate that the uptrend is slowly  losing momentum.

Breakout Strategy

Following  a sideways period  if the price breaks below or above that channel with the channel then starting to angle towards the same way then it could  mean that  a new trend could be underway in the breakout direction

Using Keltner Channels with Other Indicators

Sometimes there is no such thing as enough confirmation especially when the stock market is concerned and if you want some of that then you could always use the Keltner Channels with other indicators to improve its accuracy.

So among the indicators you could use with it can be the Bollinger Bands and even the RSI to confirm overbought or oversold conditions.

Keltner Channel Strategies for Different Trading Styles

Now that you have a fair idea of how you can trade with this indicator you may be curious about how it relates to some of the popular trading styles found within the landscape. If so then this is exactly what this section will cover so look no further.

Day Trading with Keltner Channels

Day trading typically involves traders who are more focused on the short term gains of their trading endeavors. If you happen to fall into these categories then you could always shorten the number of periods for your indicator or you could employ a shorter EMA which can respond quickly to price changes.

Some of the strategies that you could use would be scalping and trend following.

Swing Trading with Keltner Channels

Unlike day trading swing trading is typically centered around medium to long term profitability and in case you’re a swing trader then you could always increase the lookback period to better reflect your trading needs.

Strategies that can make better use out of the increased time with which you’re working yourself with can include reversals.

Long-Term Investing with Keltner Channels

But what if its the long run that has you interested? Or what if you’re long term trader?

Then like with the day and swing traders adjust your time frames accordingly and you could be more on the lookout for reversals and breakouts since you’re in for the long haul and are looking for profits that better suit that.

Advantages and Limitations of Keltner Channels

Take any indicator and you’ll likely have to deal with some type of limitations or another and understanding those can go a long way in making you a better trader.

Benefits of Using Keltner Channels

The Keltner Channels can be good for confirming trends and finding out which direction they’ve been heading towards. They can also be used to find  out breakouts and determine whether trends are losing momentum and are about to reverse.

Limitations of Keltner Channels

How useful these Keltner Channels are largely depends on what settings you’re using so you may spend a considerable amount of time just deciding how you’re going to use the indicator or how you’ll set it up. Not only that but some of the uses we mentioned earlier wont work if those bands are too far apart or narrow.

The bands can also not serve as resistance or support and their forecasting ability may be limited or not there at all which could be because of the settings you’ve chosen. Also it’s not guaranteed that the price hitting one of the bands will result in something substantial happening.

Conclusion

Keltner Channels are capable of tracking volatility by using the EMA of an asset and its true range. You as a trader could then use it to look for trend directions, price strengths and weaknesses and potential reversals.