Like all technical indicators, the Keltner Channel uses price action to predict possible future direction and amplitude of a move. Keltner Channels employ an EMA (Exponential Moving Average) as the middle line (usual a 20 EMA) and upper and lower lines priced at 2 ATR (Average True Range).
Keltner Channels are a volatility indicator with the upper and lower lines expanding and contracting based on the average price movement of the currency pair (ATR).
The idea with Keltner channels is to give an indication of direction (bullish or bearish or choppy) and possible magnitude of the move. In trending markets, the upper line often acts as resistance while the middle line often acts as support.
Below is a 15 minute chart of the EUR/USD chart with a Keltner channel of 14 EMA and 1 ATR for the upper and bottom lines.
Notice how many times the currency traded within the upper and bottom lines of the channel. Also notice that in strong trends (in this case bullish), the Keltner channel correctly identified the outside bands of price action both to the upside and to the downside.
The Keltner channel is powerful because it helps traders know the trend, the potential magnitude of a move and clear areas for stop losses and profit targets. Many less experienced traders struggle to consistently predict potential magnitude of a move which may cause them to miss out on profits. The Keltner channel makes it easier for these traders to see where to set profit target and stop loss orders.
The success of any trader comes from good trade management. Setting profit targets and stop losses before entry helps a trader execute their plan even if they experience what the military describes as the “fog of war” once they get into a trade.
Sometimes we get so caught up in not losing money in our trades that we can’t really make any money. We tend to let our losses run and cut our profits short. Using a Keltner channel to set stops and profit targets even before entering a trade gives the trader a plan and helps them execute that plan consistently on every trade.