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Definition: Keltner Channel
Keltner channel is an indicator in technical analysis which is named after Chester W. Keltner who described about the indicator in his book “How to make money in Commodities”. It is basically a volatility based envelope indicator. It consists of a moving average line enveloped by an upper band and a lower band. It is similar to a Bollinger band except that unlike in Bollinger band which uses standard deviation to set the bands, Keltner channel uses Average true range (ATR).
There are many variations in calculating the central line. Most often a 10day/20 day Simple/Exponential Moving Average of the typical price is used as the central line.
Then, the 10 day Simple Moving Average of the trading range (high to low) is calculated (Wilder’s approach uses a variation in which a simple multiple of the SMA say 1.5xSMA is added and subtracted to get the bands) and this number is added to the central line to get the Upper band and subtracted from the central line to get the lower line.
A close above the upper line indicates a strong bullish signal and a close below the lower line indicates a strong bearish signal and the buying and selling can be done accordingly. It is a trend following indicator and as with all other technical indicators it must be complemented by confirmation from other indicators
However, when the market is not following any trend, it is found that using Keltner channel as an Overbought/Oversold indicator yields better results. Thus, when the closing price is above the lower band, it indicates an oversold situation and hence is a BUY signal and if the price closes below upper band it indicates overbought situation and is a strong SELL signal.