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Keltner Channels

Keltner Channels were developed by Chester W. Keltner. They were first introduced in the book How To Make Money in Commodities, by Chester W. Keltner and are explained in the book The New Commodity Trading System and Methods by Perry Kaufman.

Keltner channels as are Bollinger Bands and fixed width envelopes are  moving average band.

Moving average bands and channels all fall into the general category of envelops, which consist of three lines – a middle line and two outer lines. Envelope theory holds that price has the greatest probability of falling within the boundaries of the envelope. Price falling outside the envelope boundaries is considered an anomaly and therefore provides a trading opportunity. The major differences between an envelope types can be found in the calculation of the lines, in the spacing between the lines or bandwidth, and how they are interpreted.
Source: Stocks & Commodities V17:12(533-538)

Construction of Keltner Channels is simple. You have a mid band based on the average of the high, low and closing price with a band on each side formed from the 10 moving average of the daily high minus the daily low. This would be represented as:

       Average Price (AP) = (C+H+L)/3
       Band Moving Average = 10 Day Simple Moving Average (SMA)
            of (High – Low)
       Middle Moving Average = 10 Day SMA of AP
         Upper Band
= Middle Moving Average + Band MA
         Lower Band
= Middle Moving Average – Band MA

This can be viewed in the below diagram.

DIAL

  Created in MetaStock from Equis International
www.equis.com

For those using  Metastock™, the formula is:

Formula #1:
NAME: The 10-Day Moving Average:
FORMULA: MOV( (H+L+C)/3, 10, Simple )

Formula #2:
NAME: Upper Keltner Band
FORMULA: MOV((H+L+C)/3,10,S) + MOV((H-L),10,S)

Formula #3:
NAME: Lower Keltner Band
FORMULA: MOV((H+L+C)/3,10,S) - MOV((H-L),10,S)
Source: Metastock

Interpretation

Originally, Keltner had his system buy when the close exceed the upper channel and sell when the close was below the lower channel. Basically, penetration exceeding the channels showed a strong bullish or bearish momentum and presumably the momentum would continue.

However, there is no reason why the Keltner Channel cannot be interpreted the same way as other price envelopes such as Bollinger Bands. When using Bollinger Bands ninety five percent of price movement occurs within the bands. The upper and lower bands are considered as extremes of the price movement and are a warning that price exhaustion may be occurring. Buy signals occur when the price is below the lower band and sell signal occur when price exceeds the upper band.

Recommendations

I prefer using the Keltner channels with a 10 day exponential average. And I would use other indicators such as Stochastic, MACD, RSI or Williams %R to confirm overbought and oversold conditions.

References and Additional Reading
Evans, Stuart (1999). Keltner Channels
Kaufman, Perry J. (1998). Trading Systems and Methods

 

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