One of the best technical analysis indicator tools for determining possible buy and sell signals is Keltner Channels. It is used for identifying trends and for identifying overbought and oversold levels during a flat trend.
What is Keltner Channels?
Created by Chester Keltner in 1960, Keltner Channels is basically a moving average band indicator. This trend following indicator makes use of moving averages and average true to identify reversals with channel breakouts and channel direction.
There are 3 basic parts of a Keltner Channel. They are midline (center line), Upper Channel, and Lower Channel.
- Centerline: This is the 10-day moving average of each day’s (High + Low + Close) / 3.
- Upper band: The upper band is drawn from the 10-day moving average of each day’s high minus low.
- Lower band: The lower band is the inverse of the 10-day moving average of each day’s high minus low.
The figure below shows the components of the Keltner Channel.
Keltner Channels and Trends
Keltner Channels can be used for identifying the trend.
- Uptrend: When the stock is trending higher, it would usually reach near the upper band or even move past the upper band. The price moves above the lower band and moves above (or just below) the middleline.
- Downtrend: When the stock is trending lower, it usually reaches very close to the lower band or even moves below it. The price also typically stays below the upper band, and stay below (or just above) the middleline.
Keltner Channels and Oversold/ Overbought Levels
Keltner Channels can be used for identifying overbought and oversold levels in case the market is flat or trendless. Typically, this leads to price corrections and the price tends to move towards the middle line.
- Oversold: This is when the stock trades near the lower channel. The stock then usually encounter buying pressure and then trade back up towards the middle or upper channel.
- Overbought: This is when the stock trades near the upper channel. The stock then usually encounter selling pressure and then trade back down towards the middle or lower channel.
How Traders Use Keltner Channels For Trading
Following are the various trading strategies wherein Keltner Channels is used by traders.
- If the price breaks above the upper band in the first 30 minutes after the market opens, traders buy the stock. Traders exit the trade when the price touches the middle band.
- In case of a ranging market, traders go long when price turn up at (or below) the lower band. Traders exit the trade when the price moves down when it is close to the upper band or if it crosses to below the middle line.
- If the price drops below the lower band, traders short sell the stock. Traders exit the trade when the price touches the middle band.
- In case of a ranging market, traders go short when price turns down at (or above) the upper band. Traders exit the trade when the price moves up when it is close to the lower band or if it crosses to above the middle line.
The figure below shows how to choose long or short positions based on the Keltner Channels.