Keltner Channels are volatility-based envelopes that are set above and below an exponential moving average. This technical indicator is similar to the Bollinger Bands, which make use of the standard deviation to set the bands.
However, Keltner Channels use the Average True Range to set the channel distance, instead of utilizing the standard deviation. The channels re normally set two Average True Range values above and below the 20-day exponential moving average. The exponential moving average determines the direction, while the Average True Range sets the width of the channel.
This technical indicator is a trend following indicator and are utilized for identifying reversals with channel breakouts and direction. Keltner channels can also be used for determining oversold and overbought channels when the trend is flat.
Technical indicators that are based on channels, envelopes, and bands are designed to cover most price action. With this, price movements below or above the channel lines need to be kept an eye on as these are rare. Trends typically begin with strong price movement in one direction or another.
A rally higher than the upper channel line displays unusual strength, while a decline below the lower channel line displays unusual weakness. These strong price movements can mark the end of a trend and the beginning of another trend.
Basically, an uptrend is present when the channel moves higher, while a downtrend is present when the channel moves higher. Meanwhile, if the channel moves sideways, the trend is flat.
Bearish trades are favored in a downtrend and bullish trades are favored in an uptrend. For a flat trend, traders should take a more nimble approach as the price normally peak at the upper channel line and trough at the lower channel line.
The Keltner Channels must be used in conjunction with other technical indicators, especially momentum indicators.