Volatility can be measured in many ways, not the least of which is by using Keltner channels to help determine where the action is, and where it might be headed next. Any Forex trader who has been at it for some period of time knows that measuring volatility is just part of the job. They need to do so if they want to have some idea about where their trades are likely to end up.
It is so important that many traders will not trade when market conditions are either too volatile or not volatile enough (depending on their trading strategy). Therefore, no one should be surprised by the fact that Forex traders like to use tools such as the Keltner Channels to try to determine how much volatility exists in a currency pair.
The Keltner Channel is fairly comparable to Bollinger Bands in that it also contains three lines. However, the middle line in a Keltner Channel is an Exponential Moving Average (EMA) and the two outside lines are built on the Average True Range (ATR) instead of standard deviations.
Since the channel is drawn from the ATR, which is a volatility indicator itself, the Keltner Channel also contracts and expands with volatility, but is not as volatile as the Bollinger Bands.
Essentially, traders can use Keltner Channels for setting trade entries and exits. The Keltner Channel helps traders detect overbought and oversold levels compared to a moving average, especially when there is a flat trend.
As we mentioned, what the Keltner Channels try to do is measure volatility levels relative to the moving average that has been established. They are particularly useful when things are relatively quiet and the market is moving much in one direction or the other. When that is the case, it can be challenging to determine where the market is headed at all. Thus, people turn to the Keltner Channels to try to get a great sense of what is really happening.
They want to know if the action that they are seeing in the market right now is, and then they want to make their trades based on that information. There is nothing wrong with this, but be mindful that you need to confirm what you are seeing is real before you jump right in with confidence.
Keltner channels are designed to show where a particular currency pair tends to spend most of its time. If the channel gets broken in the course of trading, then this may be a big signal that something fundamental has changed, and it might be time for the trader to try to determine how they need to change their own trading strategy to match what the market has thrown at them.
It is entirely possible that they need to reverse course and flip the script on the strategy that they had been using before. These channels are very powerful, and price movement that breaks through them is something to stand up and take note of. You don’t want to get caught chasing a trend that is no longer in play. Therefore, you ought to perk up and pay extra close attention to what is going on with the Keltner channels at all times.
How to Trade Using Keltner Channels
Keltner Channels as Dynamic Support and Resistance
Much like moving averages and Bollinger Bands, often Keltner Channels serve as dynamic support and resistance, with price action often bouncing off of the outside lines — and the center EMA line.
In an uptrend, price action typically staggers around the top channel, often finding support at the middle line and resistance at the top line.
In a downtrend, price action typically staggers around the bottom channel, often finding resistance at the middle line and support at the bottom line.
Trading Breakouts with Keltner Channels
As with Bollinger Bands, if price breaks above or below the Keltner Channel lines, it may be a good indicator of strong price action to come.
For instance, if a candle closes above the channel top line, the move will often continue upward.
Conversely, if a candle closes below the channel bottom line, the move will often continue downward.