Number 30

Overview

The Keltner Channel is a band or envelope indicator which is made up of two bands plotted around an Exponential Moving Average (EMA), usually the 20-day EMA. The Keltner Channel is based on the Average True Range and can be used in place of standard deviation (Bollinger) bands or percentage envelopes (moving average envelopes). The main signals given by the Keltner Channel are similar to other band indicators (price crosses center, price crosses outerband) and it is considered a trend following system.

Since the Keltner Channel is a trend following system, it is important to understand the innate weakness that the Keltner Channel and other band/trend following systems have. Trend following systems work best in trending markets and tend to fail in sideways or indecisive markets because they are not meant to catch "tops and bottoms."

When using trend/band systems, it is important to include some complimentary indicators such as trendlines, RSI, Stochastics, MACD, etc. to help provide confirmation of the strength of a market. The signals from the complimentary indicators should trigger before the band/envelope. If there are conflicts in the indicators, then further review of the market strength should be considered. Ideally, the indicators should give you a series of events from warning to confirmation.

It is also important, when using trend following systems, to develop a clear exit strategy to avoid waiting for the price to penetrate a band. The addition of complimentary indicators and trendlines become particularly important during your exit, since these indicators should trigger signals before the band/envelope does.

These are the signals generated by the Keltner Channel:

Signals stay in effect until the prices close across the opposite band. This should often be tempered, however, with the use of other indicators to provide better exit opportunities.

The method for calculating the Keltner Channel (based on ATR) is as follows:

• or the top or Plus Band, the ATR is calculated over 10 periods, doubled and added to a 20-period exponential moving average
• For the bottom or Minus Band, the ATR is calculated over 10 periods, doubled and subtracted from a 20-period exponential moving average

• When prices close above the plus band, it is a signal of strength and rising prices
• When prices close below the negative band, it is a signal that prices will drop.

The following concepts from Bollinger Bands can also be applied to the Keltner Channel.

Trend

When prices move outside the bands, a continuation of the current trend is implied. Strong-trending markets will often stay on, and occasionally penetrate, the band for long periods. Watch for initial penetrations of a band, particularly if other indicators confirm a potential move.

Price targets

A move that originates at one band tends to go all the way to the other band. This observation can be used for projecting price targets. For example, if prices bounce off the lower band and cross above the 20-day moving average, the upper band becomes the upper price target. A crossing below the 20-day average would establish the lower band as a price target.

Momentum

When the price moves above or below the band, and fails to reach the band on a subsequent move, you can interpret this as a loss of momentum and a reversal is possible. Many times the subsequent move will reach a higher or lower price, but a loss of momentum is still indicated.