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Channel Pattern

Aug 13, 2018 06:00


The Channel pattern chart borrows its name from the geometry of how rivers flow. A channel is formed when the energy of the river encounters a barrier (river bed). The river will hit this barrier and reverse in the opposite direction, hitting the barrier on the other side. This zigzag pattern of flow forms the bases of the channel pattern chart. This zigzag pattern of resistance and support movements occurs in Forex Market. It is the area between two parallel trendlines – upper trendline (resistance line), and, the lower trend line (support line). Channel can also be defined as the range in which the price of a security has traded for a specific amount of time.

2. Channel Pattern Formation

Channel Trend Line : It’s a line over pivot highs or under pivot lows to show the prevailing direction of price. It is parallel to each other. Upper trendline (resistance line) is drawn by connecting price highs, and, the lower trendline (support line) is drawn by connecting price lows.  Breakout of the upper trend line will indicate an opportunity to buy, while a breakout of the lower trend line will signal a strong selling opportunity. Channel can also be defined as the range in which the price of a security has traded for a specific amount of time.

So for the channel example below, the 3 arrows located on the top(by the resistance level) are considered to be price highs. While the 3 arrows on the bottom(by the support level) are considered to be price lows. Price highs and lows refer to the price a security reaches before reversing and heading back in the other direction.

It is common that the support and resistance lines of a channel pattern chart will be tested alternately before the price breaks out. A new trend will form soon after the price has broken out of the channel chart. This newly formed trend may be short or medium term based on the volatility and movement of that current market. Channel trading is most effective for short-term trading

3.Types of Channels

In accordance to the market trend, you can have an ascending channel (upchannel), a descending channel (downchannel), or a sideways channel (ranging channel).

Ascending channel

An ascending channel is an upward tipped trading range, which surrounds the price movement as the market forms higher highs and higher lows at the same place. You can see one illustrated on the screenshot below.

As you can see from the example, the market is forming new highs and new lows with an equal amount of price movement to the upside, which renders the lines going through them (the trend line and its clone) parallel.

In order to draw an ascending channel you need to do the following:

1. Draw a trend line as described earlier.
2. Draw another line tipped at the same angle and adjust its length in accordance to the projected channel.
3. Drag the concurrent line and place it, so that it runs through the most recent high.
4. If this is an actual ascending channel, then all the previous highs should lay on the cloned line, or deviate very slightly at most.
5. Do not attempt to forcefully make the second line become parallel to the trend line. If they are mismatching, then you simply dont have a channel.

Descending channel

A descending channel is a downward tipped trading range, which surrounds the price movement as the market forms lower highs and lower lows at the same pace. You can see a down channel visualized below.

In order to draw a descending channel, you need to follow the same steps as when plotting an ascending one, just with the difference that the trend line lies above the price action, while the cloned line is below.

Ranging channel

A ranging channel, also known as a sideways or horizontal channel, is a trading range which has no difference in the angle between the nearest peaks and troughs. Basically the price is ranging within a horizontal support and resistance zone, as illustrated below.

In order to draw a horizontal channel, you need to follow the same steps as with the previous two types, but here you can choose with which side to start you can draw your trend line both below or above the price action.

4.How to draw a channel ?

More often this setup is termed as the trend channel trading strategy because it requires you to setup trendlines every time you want to find a channel.

Here are the steps that I use to form my channel:

1- Figure out a high, and, a low in the past. This will be the starting point of the channel.
2- Find another subsequent high, as well as, a subsequent low.
3- Connect the two highs to draw a line (Upper Trend Line). Connect the two lows to draw another line (Lower Trend Line).
4- If the two trend lines so obtained are near parallel, a channel is formed.

Thus, there are at least two contact points at the Upper Trendline, and, at least two contact points at the Lower Trendline.

Note:  More contact points increase the effectiveness, and, the reliability of the channel.

Channels can form on all time frames and can last as short as an hour, or last for months on end.

5. How to trade channels.

There are two ways in which to trade based on channel price movement. You can either trade the range, or you can trade the breakout, once it occurs.

Trading the range

Since the boundaries of any type of channel basically act as support and resistance. we can use the signals generated when the price meets those levels.

In the screenshot above you can see that (1) has generated a buy signal, and our upper boundary acts as a resistance, so this should be our profit target. At (2), we are provided with another buy signal, after which at (3) we exit our long position, thus securing profit, and we place a short order. As prices continue to decline through the channel, the market again touches the lower boundary at (4) where we exit our short position and enter a long one, guided by the generated buy-signal.

Trading the breakout

As you’ve already learned from the previous articles, breakouts produce very strong and broadly used trading signals, due to their high profitability. As with every other support or resistance level, prices can break through the upper or lower boundary of a channel, thus generating an entry signal.

On the example above you can see that price broke through the upper boundary, and after that continued to edge higher, thus providing a strong signal for a long entry. As we have already learned however, the possibility for a breakout to turn false always lurks around the corner, which is why it is best to wait for confirmation. It would be wise to wait for a candle to close outside the channel before placing an order, or in some cases, wait for a retest of the line.

A potential signal for an upcoming breakout out of the channel is an acceleration, which pushes the price above the upper boundary in an ascending channel or below the lower boundary in a descending channel. Most often this is due to pure emotionalism and is thus a potential sign of a price reversal. A trader, however, especially a beginner, must never bet against the current market conditions in anticipation for a price reversal, as a wrong move could be devastating. As noted above, it would be best to wait for the breakout confirmation and then enter a position with the comfort of trading with the new trend.

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