Keltner Channel for Forex Trading

Forex support and resistance indicator based on volatility

The Keltner Channel plots two bands around a central modified moving average and is similar to Bollinger Bands in the way the distance of the upper and lower bands from the average will vary according to the underlying volatility of price. As opposed to Bollinger Bands, which use standard deviation in the calculation, Keltner bands use Average True Range.

True Range was developed by J Welles Wilder Junior to represent the real highs and lows of the day to include possible gaps from the prior bar's close to the current bar's open. This is a tool that was intended more for the futures and equities markets where there is a significant time gap between the close and the following day's open. In this way, True Range is calculated by taking the maximum of:-

1. High - Low
2. The prior bar's close - Low
3. High - the prior bar's close

However, it is very unusual for these gaps to occur in the forex market since there is no time difference between one day's close and the next day's open. Thus a gap can only really effectively occur over weekends or during volatile market conditions.

A modified average is then taken of a series of True Range calculations. Clearly, if there has been a significant level of high range bars the upper and lower bands will move away from the average while a series of low range bars will cause the bands to move inwards towards the average. Thus Keltner Bands will automatically expand and contract as the market volatility rises and falls respectively.

Basic usage of the Keltner channels are two-fold:

1. In consolidating markets the upper and lower bands may be considered as approximate support and resistance where trades may be considered to take advantage of range trading.
2. Where price breaks cleanly through and closes outside one of the bands there is a higher risk of a trend in the direction of the break developing.
3. The central moving average may be used as a trailing stop when in a trending move

It is always recommended that trades are not initiated on the basis of one indicator only and utilizing other techniques such as momentum indicators (i.e., RSI, Stochastics, etc…) may be used in order to help confirm or deny the entry signals. Reference to price patterns is also preferred.

Parameter Defaults: Period = 12 (controls the measurement period for the average)
Factor = 1 (controls the placement of the bands around the average)

Plots:

Upper KC Upper Band line
Mid KC Central Moving Average
Lower KC Lower Band line

Formula:

Mid KC = "Period" length modified moving average
Upper KCv = Mid KC + "Period" length Average True Range x Factor
Lower KC = Mid KC - "Period" length Average True Range x Factor