subject: What Is Kletner Channel [print this page] It is an unwritten fact that price action cannot be determined accurately. In a price chart, there are always regions where price is more likely to foray into than regions where it is less likely to do so. As a result, price movements are oftentimes studied in price bands, envelops or channels. These technical analysis instruments clearly mark out the high probability price action regions from the other regions. In other words, they help in distinguishing the high volatility regions. While analysts copiously use tools like Bollinger Bands, Keltner Channels are not so abundantly available or used by traders, however, that does not mean they are unimportant to be worth consideration. In fact, their gradual gain of popularity, of late, itself speaks volumes of its potential.
Keltner Channel is a volatility-based price envelop used for technically analyzing the price movement of a security. The overlay is formed by a central exponential moving average (EMA) line along with channel lines at a distance above and below the central line. Its representation is similar to that of the Bollinger Bands with the difference that Keltner Channels use the Average True Range (ATR) instead of standard deviation to set the channel width. The two ATR lines, above and below the central moving average line, define the price channel. This trend following overlay is used in technical analysis for identifying reversal, show trend and overbought/oversold levels.
It was referred to as the Ten-Day Moving Average Trading Rule by its developer Chester W. Keltner, who first described it in his 1960 book How To Make Money in Commodities. Though Keltner himself never made any claims to the originality of the idea, the rule later became known as the Keltner Channels. Moreover, the original version of rule (channels), as described in the book, used a 10-day SMA of the typical price, i.e. (High+Low+Close)/3, as the center line, and 10-day SMA of high/low range was added and subtracted to form the upper/lower channel lines, respectively. In 1980, Linda Bradford Raschke introduced a new variation of Keltner Channels. As described above, this version used volatility-based indicator (ATR) to set the channel width. Over the years, the newer version became more accepted than the original version, though some traders still like to use the original version for trading purposes.
As far as the interpretation and application of the Keltner Channels are concerned, they form a useful and easy-to-use tool for technical analysis. Primarily based on an exponential moving average, Keltner Channels lag price action. The central EMA line dictates the direction of the channel. That is to say, an uptrend is present when the channel moves higher, while a downtrend exists when the channel moves lower, and the trend is flat when the channel moves sideways. Further, as any overlay based on channels or bands is usually designed to encompass most price action, a move above or below the channel lines calls for attention because of its relative rarity. For that reason, a breakout above the upper channel line indicates extraordinary strength, while a breakout of the lower channel line indicates extraordinary weakness. Bear in mind that sometimes a channel breakout does not hold and prices oscillate between the channel lines. Such trading ranges are marked by relatively flat moving averages and should be avoided. Also, in such sidewise channel moves, the channel boundaries are used to identify overbought and oversold levels.
To conclude, the rule as described by Keltner in his book is an quite useful technical analysis tool today. As trend identification is an important field of study in technical analysis, these channels provide a trend following chart overlays designed to identify the underlying trend. They are sometimes preferred over Bollinger Bands, as Keltner Channels are smoother and thereby creates a more constant width. Breakouts of the channel lines are considered extremely strong moves, however should be confirmed using other indicators. In any case, it is a healthy trading habit to back your analysis with as many tools as possible. Lastly, these easy-to-use volatility-based channels are an excellent visual representation of the price envelope that can significantly enhance ones trading decisions.
