Trend Indicator: Keltner Channel
Keltner Channels is a lagging gauge of volatility originally developed by Chester Keltner in the late 1950s with a revised version developed by Linda Bradford Ranche in the 1980s. The revised version of Keltner Channel is very similar to Bollinger Bands as it also consists of three lines. However, the midline on the Keltner Channel is Exponential Moving Average (EMA) and the second outer shift is based on the Average True Range (ATR) and not on the standard deviation.
Keltner Channel also shows overbought and oversold rates relative to the moving average, especially when the trend is flat, and can be used to confirm trading signals. Because the channel comes from the ATR, which is an indicator of volatility, Keltner Channel also contracts and develops with volatility but is not as strong as Bollinger Bands.
Keltner Channel is calculated by selecting the period for the EMA which will serve as the center line and the period for the ATR to be used as a switch for the channel above and below the center line. Once EMA and ATR are selected, you must select the transfer factor for the outer channel line.
The default settings for Keltner Channel are: displacement twice on ATR period 10 above and below EMA 20 periods. However, the principle behind the tape like Keltner Channel is that it must cover most (95%) of the price action. This can be achieved by adjusting the past period for EMA, the past period for ATR and the displacement factor.
Due to the EMA-based Keltner Channels, it is suitable for trading strategies to follow trends with prices penetrating up the top line or down the bottom line indicating their respective strengths and weaknesses.
Direction from channel can determine trend direction. Thus, the market is in a downward trend when the channel moves lower, and is in an ascending trend when the channel moves higher. This trend is also said to be flat when the channel moves sideways.
It is strongly recommended to trade according to trend. Therefore, in an ascending trend, it is possible to use a lower channel path as a buy zone with a stop placed below the channel and the target placed on the upper channel line. In downtrend it is possible to use the upper channel path as a sell zone with stops level above the channel and the target placed on the lower channel line. This strategy uses outline as an overbought and oversold level.