Keltner Channels in Forex are widely used by technical analysts and can be used as the basis of two distinct trading strategies. They share much similarity with Bollinger Bands, although the indicator output is calculated on a different basis.
Read on to learn more about the Keltner Channel, how it is calculated, how it differs from Bollinger Bands, and the details of two Keltner Channel trading strategies.
What Is the Keltner Channel Indicator?
Keltner Channel Applied to Price Chart
Traders can use a Keltner Channel to determine trend direction. The Keltner Channel indicator measures the deviation from a central moving average line using the Average True Range (ATR) indicator to determine whether a trend is likely to continue or if a new one could be starting.
When you place the Keltner Channel indicator on a chart, it appears as three lines. When the price breaks out above the top of the upper line, this suggests that an upwards trend is beginning, while conversely, a breakdown below the bottom line indicates that a downwards is starting. Traders use these signals to enter trades based on momentum and directionality, especially when the channel has been flat and almost horizontal for a while.
Most of the time, in the absence of trending conditions, the price will oscillate between the upper and lower lines of the indicator, suggesting that they could be acting as mobile support and resistance. This is when traders may look to use the indicator to trade reversals rather than trend continuation: buy when the price reaches the lower band and sell once the price reaches the upper band.
How Keltner Channels are Calculated
Keltner Channels are calculated using an exponential moving average as a basis for the mean price, typically called the “Middle Line.”. The most common one to use is the 20 EMA (exponential moving average). The “Upper Line” is calculated using the EMA +2 x Average True Range (ATR) of the past 20 periods. The “Lower Line” is calculated using the EMA + 2 x Average True Range of the past 20 periods. This is how the indicator plots the three lines on the chart.
It is worth noting that traders can change these default inputs concerning the EMA and ATR – you don’t have to use the last 20 periods as a look back.
The moving average that shows as the middle line gives you an idea of the overall trend. As the other lines are based upon that, the idea is that if momentum carries the price outside of that range, it shows strong conviction. If you are trading a market for which volume data is available, you will often see a volume burst right along with a move, which adds to its validity as a breakout signal.
Keltner Channels vs. Bollinger Bands
One of the first questions that you might ask is, “What is the difference between Keltner Channels and Bollinger Bands?” After all, they look very similar. They both have a middle line, an upper line, and a lower line. However, they are calculated quite differently.
The Bollinger Bands indicator is calculated using a Simple Moving Average (SMA) with a plotted line above and below showing two standard deviations from that price. This indicator gives you an idea of “overbought” and “oversold” conditions, when prices move outside the bands.
However, the Keltner Channel indicator uses an Exponential Moving Average (EMA) and plots its upper and lower lines based upon 2 x Average True Range. This is a slight variation, and both indicators do tend to generate the same signals at the same time. While both indicators are valid, they are often traded quite differently.
The Average True Range is an indicator that many day traders use, so it is worth noting that it makes a certain amount of sense to pay attention to it. Once a market breaks 2 x of the ATR, it sends quite a strong message about the direction of a trend, so there is something especially logical and appealing about using a Keltner Channel if you are seeking an indicator to signal this kind of thing.
Keltner Channel Trading Strategies
Here are three of the most popular Keltner Channel trading strategies:
The pullback strategy is a popular Keltner Channel trading strategy which involves buying pullbacks in an uptrend or selling rallies in a downtrend. The idea is that a market that breaks out of the channel and then pulls back to the Middle Line should find traders willing to step in and bet on a continuation of the trend.
The price needs to break out of the Keltner Channel before you should look for a pullback. This is like “buying on the dips” or “selling on the rips.” This can be an effective way to enter an existing move without “chasing the trade.” If you are familiar with Fibonacci retracement-based trade entries, the idea is very similar.
Pullback to Middle Line of Keltner Channel in Trend
The breakout strategy attempts to catch more significant directional moves. The idea is to enter a trade at the start of the move, and as a result, you may have a higher number of losers, but you will catch the bigger moves to compensate.
The Keltner Channel needs to be horizontally flat before you look for an entry with this strategy. Once the price breaks the top or bottom of the channel, you enter in the direction of the breakout, hoping for sustained movement. This breakout strategy is often used together with other indicators, such as the ADX or MACD. These additional indicators can be used as a ‘filter’ for the signal.
If the trade moves nicely into profit, it can be helpful to not exit the trade until the price breaks back to the other side of the Middle Line of the Keltner Channel.
This strategy will quite often produce a few small losses and then a significant gain here and there to make it profitable overall. This can be a great strategy for catching bigger trend moves.
Keltner Channel Breakout
Combining the Trend-Pullback and Breakout Strategies
Some traders will use a combination of these two strategies to enter and exit the markets. The most aggressive version adds to an existing position on pullbacks to the Middle Line that bounce again. Another way this strategy combination can be used is for stop loss placement. This uses the Middle Line as a dynamic stop loss, and therefore the stop loss order will ‘trail’ the EMA which represents the Middle Line.
Keltner Channel Breakout and Pullback Combined Entries
There are limitations to all trading indicators, as there is always a struggle between signal and noise. The Keltner Channel indicator should be tuned to your trading style. If you want fewer but more accurate signals, use a slow EMA as the Middle Line. If you want more but less accurate signals, use a faster EMA Middle Line setting.
It is important to keep in mind that Keltner Channels are lagging indicators, meaning that they are based upon historical data, and so you can get whipsawed during trend changes as multiple signals can be generated very quickly. This is seen in all lagging indicators and is not unique to the Keltner Channel.
Setting up Keltner Channels in MT4 or MT5 is a bit more difficult than other indicators, as most brokers do not include the indicator within their platform presets. However, you can download it for free from several internet sites and add it to your MetaTrader platform. The indicator typically comes in a zip file that you extract and place in your installation’s “indicators” folder.
Which is better, Bollinger Bands or Keltner Channels?
The better indicator will come down to the way an individual trades. The main difference is that the Keltner Channel represents volatility using the high and the low prices of a specific timeframe, while Bollinger Bands represent standard deviation. The Keltner Channel typically gives you a smoother channel than Bollinger Bands do.
What is the Keltner Channel indicator?
The Keltner Channel indicator is measures volatility based on the highs and lows of an instrument’s price. There are three lines on the chart, including a “mean price” and 2 x Average True Range, both above and below that level. These preset values can be customized and changed by the trader.
Is the Keltner Channel a lagging indicator?
The Keltner Channel indicator is a lagging indicator. It is like moving averages and other trend-following indicators, as the trend dictates the direction of the channel.
How do I use Keltner Channels with Bollinger Bands?
Usually when traders use these indicators, they will change the default settings for one of them. The idea behind using both together is that if the Bollinger Bands and the Keltner Channels both give signals in the same direction, that is when you buy or sell, based upon what they both tell you. However, it is worth noting that there is a strong possibility that you may get “paralysis through analysis,” which can happen when you start combining similar indicators and wait for the perfect setup.
What are the default settings for the Keltner Channel?
The default settings in the Keltner Channel indicator include the Middle Line, which is a 20-period Exponential Moving Average, the Upper Channel Line, which is the 20 EMA + 2 x Average True Range, and the Lower Channel Line, which is the 20 EMA - 2 x Average True Range.
What is the shift in a Keltner Channel?
The Shift in the Keltner Channel is the number of Average True Ranges above and below the moving average used to draw the bands. The standard shift is 2x, but traders can adjust this.