How is the Keltner Channel Constructed?

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( — February 13, 2020) — The Keltner channel is an indicator used in the technical analysis. It was designed by Chester W. Keltner and was published in his book in the 1960’s.

Despite being quite old, the Keltner channel is a respectable and one of the popular indicators in the forex markets, among others. Typically, the Keltner channel falls into the category of bands. Bands in technical analysis are a set of indicators which have an upper and a lower range. 

Some of the common examples of bands in technical analysis include the Bollinger bands, Envelopes, Donchian channels to name a few. The Keltner channel is unique from most of the other band indicators.

Traders use bands, both as a breakout indicator as well as to outline the trends in prices. At times, bands can also indicate potential overbought and oversold levels.

How is the Keltner Channel Constructed?

It always helps to understand how an indicator works even though many are automatic and there is no need to do the calculations manually. The Keltner channel takes into account volatility based on the average true range indicator.

Keltner Channel Indicator

Keltner Channel Indicator

The Keltner channel has three lines. These are the upper and lower channel lines and the midline.

The Keltner Channel uses a 10-period or a 20-period setting, of an exponential moving average. The exponential moving average forms the basis from the typical price (H+L+C/3).

The upper line is formulated by taking the mid-line value and multiplying by 1.5. The result is then added to the midline’s value to form the upper line.

Likewise, when you subtract the same number from the mid-line, you get the lower Keltner channel.

In total, the Keltner channel has a setting of 10 or 20 period with a multiple of 1.5. Traders can experiment with these values to make it more or less sensitive to price and volatility.

The Keltner channels, because of using volatility, tend to slightly expand or contract. This depicts the volatility in the price action of the security.

Catching Trends Using the Keltner Channel

During a strong trend, price tends to trade consistently above or below the lower Keltner channel. However, due to the reversion to the mean theory, prices often snap back to the mid-line of the Keltner channel.

Buy and sell signals are forming, thus indicating a strong breakout from either of the outer bands. When price stays within the band but reaches one of the outer bands, it can signal oversold or overbought levels by just looking at the Keltner channel.

Trading Forex Using Keltner Channels

Over the years, traders have come up with different ways of using the Keltner channel in their trading systems. But quite often, traders make the mistake of using redundant indicators. For example, using a Keltner channel alongside an additional moving average.

Yet, some methods are quite interesting. For example, the Bollinger band squeeze and the Keltner channel is a popular way of trading. The basis of this method is that when volatility contracts, the Bollinger bands also contract.

Keltner Channels IndicatorKeltner Channel Indicator

In turn, at times, the bands tend to squeeze within the Keltner channel. This period represents extremely low volatility. But it also portends a possible breakout or higher volatility. When the Bollinger band squeezes into the Keltner channel, traders may prepare for a breakout trade.

Depending on the slope of the Bollinger bands and the Keltner channels, traders can take long or short positions.

The chart above gives one such example of a Bollinger band squeeze within the Keltner channel.

In conclusion, the Keltner channel is a fairly reliable technical indicator that has stood the test of time. Traders can use this indicator as one of many when trading with bands. The indicator is useful if the trader wants to rely on trends and volatility as the main determinants of their trading strategy.