Earlier on this blog, we have talked about two indicators- The Moving Averages and Average True Range (ATR). The moving averages are trend indicators, while ATR is a volatility indicator. The Keltner Channels, the indicator that we are going to discuss today, combines these two concepts to make a price envelop around a middle line. Keltner channels stand out for its ability to spot breakouts, measure trend strength and depict potential reversals in a simple yet clear manner.
Let's commence to learn this indicator.
What is Keltner Channel?
A Keltner Channel is a volatility indicator having a middle line and two channel lines that envelop the middle line from above and below. The channel looks like Bollinger Bands but differs from it in the way the lines and channels are calculated. Let's see this in a chart.
The image below shows a NIFTY daily chart with Keltner channel plotted in it.
Further, the middle line is an Exponential Moving Average (EMA) for a specified period (usually a 20 period) and the channel above a below the EMA is plotted by using ATR. You would learn the details of this when we discuss the calculation of Keltner channel in next paragraph.
Keltner Channels Calculation-
As discussed above a Keltner channel has three lines.
The middle line is an exponential moving average for a specified period. The default period is usually a 20 period, but you can set it to any number of your preference.
Upper line- the upper line of channel is calculated by adding a fixed multiple of ATR in EMA.
Upper line = EMA (20 period default) + multiplier * ATR
The default multiplier is usually 2 but you can set it to any number based on your trading strategy and preference.So, the default upper line is-
Default Upper line = 20EMA + 2 * ATR
Similarly, you can calculate lower line by subtracting a fixed multiplier of ATR from A specified period EMA.
Lower line = EMA (20 period default) - multiplier * ATR
The default multiplier is 2 so, the default lower line would be-
Default lower line = 20EMA - 2 * ATR.
We have already discussed the calculation of ATR in a separate post on the topic- Average True Range (ATR) indicator- step by step tutorial for beginners.
Furthermore, since the ATR value changes according to underlying volatility of a stock, so, the width of keltner channel varies based on volatility. Let's see this in a chart.
The chart above shows varying width of Keltner channel based on volatility. You would notice that the Channel width is lesser on the left-hand side when price movements are not so volatile but on right-hand side of the chart, the channel widens as the volatility increases.
Now that you have got a basic idea of Keltner channels, let's dive deeper into the interpretation part of the indicator.
How to read Keltner Channel signals?-
The price touching or breaking the upper or lower channel lines generates signals in Keltner Channels. However, these signals should always be considered in accordance with the overall trend. A price breakout above the upper channel signifies different things depending on whether the overall trend is upward or downward.
Let's understand this in detail.
In an uptrend, price breaching the upper channel suggests the price is overstretched on the upside and you should wait for the price to come lower towards the middle line before entering a buy position. While price breaching the lower channel when the stock is in uptrend, suggests there is probable reversal.
Let' understand this with the help of a chart.
Similarly, in a downtrend price crossing above upper channel suggests a probable reversal and price crossing below the lower channel suggests an oversold condition and a probable correction. Let's see this in a chart.
In a sideways trend, price breaking above or below the upper or lower channels suggests a possible breakout or breakdown, respectively, as shown in a chart below.
Keltner channel for trend identification- According to one of the articles on Avatrade on Keltner Channel, it can also be used for trend determination. An up-sloping or rising channel suggests an uptrend while a down-sloping or falling channel indicates a downtrend. A flat channel suggests a sideways trend
Trading Strategies with Keltner Channels-
In trading setups Keltner channel is usually used to identify trends, breakouts and overbought and oversold conditions. However, just like other indicators, traders should not use it in isolation; rather, they should couple the indicator with other indicators, overall trend, and price action. Here are some ways Keltner channel can be used in trading setups.
Pullback entries in a trending market- As discussed earlier in the post, price crossing above the upper Keltner channel in an uptrend suggests an overbought condition. This would not be the right time to open a new position. A better place to buy would be when price reverts towards the middle line. Similarly in a downtrend, price crossing below the lower channel mean the stock is oversold and you should wait for price to come back towards middle line before entering a short position.
Let's see this in a chart.
Mean reversion trading strategy- This strategy works in a sideways market. Here you should look to buy when price touches the lower band of keltner channel and short when price touches the upper line of the channel. Additionally, an oscillator like, RSI or Stochastic can be used to confirm the signal.
Keltner channel with MACD- Use MACD for trend and momentum confirmation and buy when price touches the upper band and MACD line is above signal line. Do reverse for a sell setup. Exit the position when MACD shows either a diversion or a sell signal.
Let's understand this with the help of a chart.
KC squeeze using Keltner channel and Bollinger Band- During phases of low volatility, the Keltner channel and Bollinger band become narrow, they get squeezed. A period of higher volatility often follows this period of squeeze when you can make large profits in a short period.
When Bollinger band squeezes inside the Keltner channel, it signals low volatility. You can enter a trade once the price breaks out from this squeeze in the direction breakout. Stoploss in such trades is usually placed around the middle line of Keltner channel.
Let's visualize this in a chart.
Breakout trading strategy using Keltner Channel- Keltner channels are excellent tools to spot breakouts. In a sideways market, price breaking out of one of the upper or lower channel signals a breakout. However, to mitigate the probability of false breakouts, you should always confirm it with volume. An increase in volume when price breaks out of channel is a powerful signal to trade in the direction of breakout.
These are some of the trading strategies to use with the Keltner channel. While this is not the exhaustive list of strategies, it lists the ones commonly used. For more you can checkout this article on LuxAlgo on Keltner channel.
The Bottom line
The Keltner Channel is a versatile indicator that blends trend analysis with volatility measurement by combining EMA and ATR. It helps traders identify trends, pullback opportunities, overbought/oversold conditions, and potential breakouts. While powerful on its own, it works best when paired with other tools like MACD, RSI, or Bollinger Bands for confirmation. By understanding how to read price movements relative to the channel, traders can improve timing, filter false signals, and build more effective trading strategies.
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