Keltner Channels (KC)
Definition Keltner Channels (KC)
The Keltner Channels (KC) indicator is a banded indicator similar to Bollinger Bands and Moving Average Envelopes. They consist of an Upper Envelope above a Middle Line as well as a Lower Envelope below the Middle Line. The Middle Line is a moving average of price over a user-defined time period. Either a simple moving average or an exponential moving average are typically used. The Upper and Lower Envelopes are set a (user-defined multiple) of a range away from the Middle Line. This can be a multiple of the daily high/low range, or more commonly a multiple of the Average True Range.
The basic idea behind the Keltner Channels indicator was introduced by Chester Keltner in his 1960 book How to Make Money in Commodities. Since then, his ideas have been expanded upon and simplified, most notably by Linda Bradford Raschke.
Raschke popularized using an exponential moving average for the middle line and using Average True Range for the envelopes.
For this example we will use a 20 Period EMA with Envelopes using Average True Range and a multiplier of 1:
Basis = 20 Period EMA Upper Envelope = 20 Period EMA + (2 X ATR) Lower Envelope = 20 Period EMA - (2 X ATR)
Much like any indicator that is based around a moving average, The Keltner Channels (KC) indicator is a lagging indicator. Moving averages inherently lag behind price and therefore so do any bands or envelopes that are calculated using a moving average. The main occurrences to look for when using Keltner Channels are breakthroughs above the Upper Envelope or below the Lower Envelope. A breakthrough above the Upper Envelope signifies overbought conditions. A breakthrough below the Lower Envelope signifies oversold conditions.
Keep in mind however when using Keltner Channels, that overbought and oversold conditions are oftentimes a sign of strength. During a clearly defined trend, overbought and oversold conditions can signify strength. In this case, the current trend would strengthen and ultimately continue. It works a little bit different in a sideways market. When the market is trending sideways, overbought and oversold readings are frequently followed by price moving back towards the moving average (Middle Line).
In terms of trend identification and determining overbought and oversold levels, the Keltner Channels indicator does this effectively. It is one of a number of banded indicators that accomplishes this task, just in its own way. While Keltner Channels can be used independently, it is best to use them with additional technical analysis tools. Historical analysis may also be helpful when trying to determine the correct parameters when setting up the indicator. Different securities may require a different multiplier to adjust the width of the bands or envelopes.