The Keltner Channel is a chart that displays a technical analysis of stock prices to determine price volatility and market trends. The chart consists of three lines, or bands. The middle line illustrates a moving average of the stock’s price. A number is used to add or subtract from the stock prices to create the top and lower bands.
The middle band is usually either a 10-day or 20-day moving average of the stock price. The investor creating the chart determines the number used in the calculations that plot the upper and lower bands of the Keltner Channel. A multiple of 1.5 is commonly used. This number is called an average true range multiplier. The multiplier creates the Keltner channel settings.
Chester W. Keltner publicized this technical analysis in his 1960 book How to Make Money in Commodities. He called it the Ten-Day Moving Average Trading Rule. Although it is unclear whether Keltner created this analysis, it is now known as the Keltner Channel.
The investor tracks the stock price in relation to how it moves throughout these three bands to predict market trends. Most often, when the stock price moves above the upper band, it is a signal to buy. Conversely, when the stock price falls below the bottom band, the chart indicates a sell signal.
Some investors take the opposite approach. They buy when the stock price falls below the bottom band. When the stock price goes above the top band, these investors treat this as a signal to sell the stock.
Investors who buy or sell outside the bands are following price trends. A trend occurs when a price continually moves in one direction. If a market is trendless, then investors can still use the Keltner Channel for buy and sell signals.
In a trendless market, the channel can help predict when a stock is overbought or oversold. Investors capitalize on these situations to make a profit. When a price breaks out below the lower band, it is oversold. Investors wait until the price closes back inside the band to buy the stock. This waiting helps ensure that the stock is not starting a downward trend.
When a stock closes above the upper band in a trendless market, this is an oversold indicator. To avoid large losses, the investor waits until the price is back inside the band to sell the stock. Waiting for the price to move ensures that the high price is not the beginning of a true upward trend. This helps the investor ensure that he does not sell too early.
As with other market trends analysis, the Keltner Channel is not infallible. Savvy investors use this as only a part of their analysis when deciding when to buy or sell a particular stock. Combined with other techniques, charting stock prices with this technique can help an investor make informed decisions.