Keltner Channels is a volatility indicator introduced by a grain trader named Chester Keltner in his 1960 book, How To Make Money in Commodities.
A revised version was later developed by Linda Raschke in the 1980s.
Linda’s version of the Keltner Channel, which is more widely used, is quite similar to Bollinger Bands in that it also consists of three lines.
However, the middle line in a Keltner Channel is an Exponential Moving Average (EMA), and the two outer lines are based on the Average True Range (ATR) rather than on standard deviations (SD).Because the channel is derived from the ATR, which is a volatility indicator itself, the Keltner Channel also contracts and expands with volatility, but is not as volatile as the Bollinger Bands.
Keltner Channels serve as a guide for setting trade entries and exits.
The Keltner Channel helps identify overbought and oversold levels relative to a moving average, especially when the trend is flat.
It can also provide clues for new trends.
Think of the channel like an ascending or descending channel, except it automatically adjusts to recent volatility and isn’t made up of straight lines.
If you’ve read our lesson on Bollinger Bands, you’re probably guessing that Keltner Channels are basically cut from the same cloth. Well, almost.
What sets these two apart are the underlying indicators and calculations that we could go on and on about… but might lull you to sleep.
Let’s just say that these formulas yield differences in price sensitivity and the smoothness of the indicators.
Okay, let’s review what you’ve learned so far…
What is the Keltner Channel?
The Keltner Channel is a volatility-based indicator made up of three lines:
- Middle Line: An Exponential Moving Average (EMA), usually set to 20 periods.
- Upper Band: The EMA plus a multiple (commonly 2) of the Average True Range (ATR).
- Lower Band: The EMA minus the same multiple of the ATR.
The ATR measures price volatility, so when the market is more volatile, the channel widens; when it’s calmer, the channel narrows.
What does the Keltner Channel show?
Trend Direction:
- If the channel is sloping upward, the market is in an uptrend.
- If it’s sloping downward, it’s a downtrend.
- A flat channel signals a sideways or ranging market.
Dynamic Support and Resistance:
- The upper and lower bands act as moving resistance and support levels.
- Price often bounces between these bands, especially in sideways markets.
Overbought and Oversold Conditions:
- When the price touches or exceeds the upper band, the market may be overbought.
- When it touches or falls below the lower band, it may be oversold.
- However, in strong trends, price can “ride” the band for some time.
How to Trade Forex Using Keltner Channels
Keltner Channels show the area where a currency pair normally hangs out.
The channel top typically holds as dynamic resistance while the channel bottom serves as a dynamic support.
How to Use Keltner Channels as Dynamic Support and Resistance Levels
The most commonly used settings are 2 x ATR (10) for the upper and lower lines and EMA (20), which is the middle line.
This middle line is pretty significant since it tends to act as a pullback level during ongoing trends.
In a UPTREND, the price action tends to be confined in the UPPER HALF of the channel, which is between the middle line as support and the top line as resistance.
In a DOWNTREND, price action usually hangs around the BOTTOM HALF of the channel, finding resistance at the middle line and support at the bottom line.
In a RANGING MARKET, price usually swings back and forth between the top and bottom lines.
How to Trade Breakouts Using Keltner Channels
Breakouts from the Keltner Channel act as strong hints where the price is running off to next.
If the candles start to break out above the TOP, then the move will usually continue to go UP.
If the candles start to break below the BOTTOM, then the price will usually continue to go DOWN.
Keeping an eye out for these channel breakouts can help you catch a big move as early as possible.