|
Keltner Channels
Keltner Channels are volatility-based envelopes set above and below an exponential
moving average. This indicator is similar to Bollinger Bands, which use the
standard deviation to set the bands. Instead of using the standard deviation,
Keltner Channels use the Average True Range (ATR) to set channel distance. The
channels are typically set two Average True Range values above and below the
20-day EMA. The exponential moving average dictates direction and the Average
True Range sets channel width. Keltner Channels are a trend following indicator
used to identify reversals with channel breakouts and channel direction. Channels
can also be used to identify overbought and oversold levels when the trend is
flat.
In his 1960 book, How to Make Money in Commodities, Chester Keltner introduced
the "Ten-Day Moving Average Trading Rule", which is credited as the
original version of Keltner Channels. This original version started with a 10-day
Simple Moving Average of the typical price as the centerline. The
10-day SMA of the High-Low range was added and subtracted to set the upper and
lower channel lines. Linda Bradford Raschke introduced the newer version of
Keltner Channels in the 1980s. Like Bollinger Bands, this new version used a
volatility based indicator, Average True Range (ATR), to set channel width.
Example
of Keltner Bands. Surges above the upper band indicates unusual strength, while
a crash below the lower band indicates extra weakness.
Interpretation
Indicators based on channels, bands and envelopes are designed to encompass
most price action. Therefore, moves above or below the channel lines warrant
attention because they are relatively rare. Trends often start with strong moves
in one direction or another. A surge above the upper channel line shows extraordinary
strength, while a plunge below the lower channel line shows extraordinary weakness.
Such strong moves can signal the end of one trend and the beginning of another.
With an exponential moving average as its foundation, Keltner Channels are
a trend following indicator. As with moving averages and trend following indicators,
Keltner Channels lag price action. The direction of the moving average dictates
the direction of the channel. In general, a downtrend is present when the channel
moves lower, while an uptrend exists when the channel moves higher. The trend
is flat when the channel moves sideways.
A channel up turn and break above the upper trendline can signal the start
of an uptrend. A channel downturn and break below the lower trendline can signal
the start a downtrend. Sometimes a strong trend does not take hold after a channel
breakout and prices oscillate between the channel lines. Such trading ranges
are marked by a relatively flat moving average. The channel boundaries can then
be used to identify overbought and oversold levels for trading purposes.
Versus Bollinger Bands
There are two differences between Keltner Channels and Bollinger Bands. First,
Keltner Channels are smoother than Bollinger Bands because the width of the
Bollinger Bands is based on the standard deviation, which is more volatile than
the Average True Range (ATR). Many consider this a plus because it creates a
more constant width. This makes Keltner Channels well suited for trend following
and trend identification. Second, Keltner Channels also use an exponential moving
average, which is more sensitive than the simple moving average used in Bollinger
Bands.
|
