Keltner Channels Indicator Explained

Definition

The Keltner Channels are a set of custom indicators which were introduced by Kester Cheltner in his book “How to Make Money in Commodities”.

Keltner1

The original version of the Keltner channels was based on what Chester Keltner labelled the “10-Day Moving Average Trading Rule”. The channels have since been modified to add the 10-day SMA applied to the High-Low range, to produce the upper and lower channel lines. This modification was performed by Linda Raschke and includes the use of the Average True Range (ATR) indicator to determine the distance between both channels. This is at variance with the Bollinger bands indicator which uses the standard deviation from the middle band to set the upper and lower bands.

Components of the Keltner Channel Indicator

Keltner Channels are actually made up of envelopes which are based on asset volatility. This sets the upper and lower channels above and below an exponential moving average which serves as the middle channel. So the components of the indicator are:

  1. Upper channel set to two ATR values above the 20-day EMA.
  2. The middle band which is a 20-day EMA
  3. Lower channel set to two ATR values below the 20EMA.

The calculations for the Keltner channels are shown below:

  • Middle Line: 20-day exponential moving average
  • Upper Channel Line: 20-day EMA + (2 x ATR(10))
  • Lower Channel Line: 20-day EMA – (2 x ATR(10))

Indicator Settings

The Keltner channel is a custom indicator. You must first add it to the indicators folder by using File -> Open Data Folder -> MQL4 -> Indicators. Then restart the platform and attach it to the MT4 chart by clicking on Insert -> Indicators -> Custom -> Keltner channels.

Keltner

You can download the indicator by clicking here.

In terms of appearance, some modifications to the indicator can be made. These modifications can be either to increase or reduce the line thickness of the lines or to change their colour to make them more visually observable.

Usage of the Keltner Channels in Forex Trading

Keltner Channels are used to detect and follow market trends. They can also be used to pick reversals by identifying overbought and oversold levels in the market during range-bound market conditions.

The Keltner Channel indicator is used with channel breakouts and channel direction to trade the trend. So these are the ways that the Keltner channels indicator is used.

1) Combination Trade Strategy

The classical description of this strategy is provided in the Bollinger squeeze strategy which aims to identify when price action will break out of the Bollinger squeeze. Previously, it was difficult to identify how and when price action would break out of the squeeze area. This was until the Keltner channels were introduced. Here the trader applies the Keltner channel, which fits into the Bollinger band squeeze. The trader waits for the upper and lower bands of the Bollinger indicator to squeeze into the boundaries of the Keltner channels, then waits for when the Bollinger bands and the price action break themselves out of the boundaries of the Keltner channels. This is the trade signal. A full description of this strategy is provided in the Forex Strategies section. You can click here to read the setups and see the diagrammatic representations in full.

2) Range Trading

The Keltner channels can be used to trade price reversals in a range-bound market. An indicator which can measure overbought or oversold market conditions such as the Stochastics oscillator or the Commodity Channel Index indicator are used to pull off this trade. The principle behind this strategy is that once the price action has reversed off one band in a consolidating market, it is likely that the price action will keep moving to the opposing band.

So the trades are as follows:

  • Enter long when the price action has bounced off the lower band and started to turn upwards. The position is followed with a trailing stop once it has breached the middle band, and the position is closed if price either hits the upper band without breaking it, or has turned downwards near the upper band and started to move down to the moving average.

Keltner_long

  • Enter short when the price action has been resisted at the upper band and started to turn downwards. The position is followed with a trailing stop once it has breached the middle band, and the position is closed if price either bounces off the lower band without breaking it, or has turned upwards near the lower band and started to move up to the moving average.

Keltner_short

Use reversal signals to identify turning points close to the upper and lower bands.

3) The Channel Breakout/Direction Trade

The simple trade setup is to use the Keltner channels as well as an indicator such as the coloured MACD indicator. The goal here is to trade in the direction of a channel break. If the upper channel is broken and there is supporting confirmation, we trade long. If there is a break of the lower channel and a supporting signal from the coloured MACD, we trade short. These are situations you can confirm from a demo account as you do your own practice.

Conclusion

It is essential that you practice how to trade each setup on a demo account before using the indicator to trade real money. Also pay attention to risk management.

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