The Keltner Channel, commonly referred to as KC, is a technical analysis tool that consists of bands based on volatility, situated above and below a moving average. These bands are typically set at two Average True Range (ATR) values above and below a central line, which is usually a 20-period Exponential Moving Average (EMA). The Keltner Channel is used to signal potential price breakouts and to offer insights into overbought and oversold conditions. This indicator is similar to Bollinger Bands (BB), but instead of using Standard Deviation (SD) to determine the distance of the bands from the moving average, it employs the Average True Range (ATR). Keltner Channels (KC) are categorized as an envelope indicator, similar to Bollinger Bands (BB) and Moving Average Envelopes (MAE). Envelopes are technical indicators that are typically overlaid on price charts, featuring upper and lower bounds. The original concept of the Keltner Channels was introduced by Chester Keltner in his 1960 book, "How to Make Money in Commodities." His ideas were later refined and simplified by Linda Bradford Raschke, a trader and Market Wizard, who popularized the use of an exponential moving average (EMA) for the Middle Line and the Average True Range (ATR) for the Upper and Lower Envelopes.

The Keltner Channel consists of three primary components: the Middle Line, the Upper Envelope (above the Middle Line), and the Lower Envelope (below the Middle Line). The Middle Line represents a moving average of price over a specified time frame, typically set to 20. While an exponential moving average (EMA) is the default option, some traders prefer a simple moving average (SMA). The distances of the Upper and Lower Envelopes from the Middle Line are determined by a specific multiple of the Average True Range. All three lines adjust with price movements, forming a channel-like structure, hence the term "channels." The Upper Keltner Channel is created by adding a calculated value to the Middle Line, while the Lower Keltner Channel is formed by subtracting that value from the Middle Line. The EMA indicates the trend direction, while the ATR multiple determines the channel's width.

Initially, Keltner used the Keltner Channels as a trend-following tool to identify the prevailing trend, but they are now also utilized to identify overbought and oversold levels. To effectively use the Keltner Channel indicator, one must first determine whether the price is trending or ranging, as this influences the strategy to adopt:

1. Trending:
   • Breakout Strategy: This method is applied when the price breaks through the Keltner Channel. Since envelope-based technical indicators are designed to encompass most price movements, any significant movement beyond the channels is noteworthy, as such occurrences are relatively rare. A rise above the upper channel indicates substantial strength, while a fall below the lower channel signifies considerable weakness. These strong movements can suggest the end of a trend and the beginning of a new one.
   • Buy Signal: Enter a long position when the price breaks out and closes above the upper channel, using the Middle Line as the exit point. There is no set profit target; exit the trade when the Middle Line is reached, regardless of profit or loss.
   • Sell Signal: Enter a short position when the price breaks down and closes below the lower channel, again using the Middle Line as the exit point.
2. Trend Pullback Strategy: This strategy is used when the price is in a strong trend, but instead of pursuing it, traders wait for temporary price weakness to re-enter the trend.
   • Buy Signal: Confirm a strong uptrend, then go long when the price retraces to the Middle Line, placing a stop loss halfway between the Middle Line and the lower channel, with a profit target near the upper channel.
   • Sell Signal: Confirm a strong downtrend, then go short when the price rallies back to the Middle Line, placing a stop loss halfway between the Middle Line and the upper channel, with a profit target near the lower channel.
3. Overbought and Oversold: In trendless market conditions, trading breakouts can be ineffective. Trendless price action is characterized by a flat moving average and a low Average Directional Index (ADX). In such cases, the Keltner Channels can act as an oscillator to identify overbought and oversold levels.
   • Buy Signal: Wait for the price to break below the lower Keltner Channel, then wait for a close back inside the channel before going long.
   • Sell Signal: Wait for the price to break above the upper Keltner Channel, then wait for a close back inside the channel before going short.

When using Keltner Channels as an overbought/oversold indicator, it is essential to remember that these conditions often indicate trend strength. "Overbought" may suggest a strong uptrend, while "oversold" could indicate a strong downtrend. The current trend may continue to strengthen, remaining overbought or oversold, so this strategy should only be applied in sideways or ranging markets.

Calculating Keltner Channels: While Chester Keltner introduced the Keltner Channels in the 1960s, Linda Bradford Raschke updated the indicator in the 1980s, and her version is the one commonly used today. Keltner Channels combine two indicators: the Exponential Moving Average (EMA) and the Average True Range (ATR). The EMA represents the average price over a set number of periods, giving more weight to recent prices, while the ATR measures volatility. Keltner Channels require three parameters:

1. Select a length for the EMA.
2. Choose the time periods for the ATR.
3. Choose the multiplier for the ATR.

The calculation for Keltner Channels is as follows:

• Upper Band = EMA + (ATR x multiplier)
• Middle Band = EMA
• Lower Band = EMA - (ATR x multiplier)

Adjustments to Keltner Channel parameters may be necessary when trading different assets, as the parameters effective for one asset may not yield the same results for another. The EMA period is typically set to 20 but can be adjusted as needed, with common lengths ranging from 15 to 40. A standard multiplier for the ATR is 2, meaning the upper band is plotted 2 x ATR above the EMA, and the lower band is plotted 2 x ATR below the EMA. Adjusting the multiplier affects the channel width; a higher multiplier results in a wider channel, while a lower multiplier narrows it.