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The Keltner Channel is a moving average band indicator whose upper and lower bands adapt to changes in volatility by using the average true range. The Keltner Channel is used to signal possible price breakouts, show trend, and give overbought and oversold readings.
There are many variations to calculating the Keltner Channel, but generally speaking a moving average (10 or 20-period) of the typical price [(High + Low + Close)/3] is used to construct the midline.
Then the average true range is calculated over a time period (same as midline, 10 or 20-period) and multiplied by a multiple (usually 1.5); the calculated number is then added to the midline to form the upper Keltner Channel and subtracted from the midline to form the lower Keltner Channel.
A chart of gold futures illustrates a Keltner Channel with a 20-day moving average and an average true range multiplier of 1.5:
There are numerous, sometimes contradictory, ways to interpret the Keltner Channel. The first method is price breakouts outside of the Keltner Channel.
Keltner Channel Possible Buy Signal
When price closes above the upper band, buy.
Keltner Channel Possible Sell Signal
When price closes below the lower band, sell.
Keltner Channels are sometimes interpreted the opposite way. Keltner Channel overbought and oversold readings is next.
Keltner Channel Overbought & Oversold
The Keltner Channel breakout methodology could work great during the transition from range-bound, trendless markets to uptrends or downtrends.
However, during those actual trendless market periods, buying breakouts might be costly. During trendless periods, using the Keltner Channel as an overbought/oversold indicator might prove profitable.
The chart below of the Nasdaq 100 ETF (QQQQ) shows an example of a trendless market:
Please note, this is an example trade – not a recommendation.
Keltner Channel Oversold Potential Buy Signal
A trader might see a price breakout below the lower Keltner Channel band, and wait until the price closes back inside the Keltner Channel. By waiting for a close back inside the Keltner Channel, a trader might avoid getting caught in a true Keltner Channel downside breakout.
Keltner Channel Overbought Potential Sell Signal
With a price breakout above the upper Keltner Channel band, it might be advisable to wait until the price closes back inside the Keltner Channel. When a trader waits for a close back inside the Keltner Channel, that trader might avoid large losses by not getting caught in a true Keltner Channel breakout to the upside.
When combined with other technical analysis indicators, Keltner Channels could be a useful tool in a trader's arsenal.
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