What is a Trading Channel?
The Trading channel is one of the best ways of dealing with trend lines. Generally, the channels are formed based on the fact that the price moves up and down from the resistance line to the support line and vice versa. Bearing this in mind and figuring out how to discover channels, you can open more positions in different timeframes.
Types of Trading Channels
Generally there are only three broad types of trading channels that are popular with technical analysts:
- Ascending channel – prices move up and the trend updates its regional peaks again and again;
- Descending channel – prices move downward and the trend updates its regional lows again and again;
- Horizontal channel – the price moves on a horizontal line and the vertices hit the same lines (resistance and support).
An ascending channel is the price action contained between upward sloping parallel lines. Higher highs and higher lows characterize this price pattern.
There are two main strategies for applying this technical analysis element: trading ranges and trading breakouts.
Let us consider both strategies for three possible situations.
Down Channel (Descending)
There is a strict rule that says the channel has to be built on at least 2 vertices for each line (resistance and support). This means that we need at least 2 highs for the resistance line and 2 lows for the support line.
As shown in the image above, we have built the channel by four points (1, 2, 3, and 4), and then we have continued to draw the line on the regional highs and lows.
Now here are our two strategies:
Trading ranges – the first strategy is to follow the price within the ranges. If the price has approached one of the two lines and did not break it – we should anticipate its movement to the opposite line. For example, if the price didn’t break the resistance line, we buy PUT options, and vice versa.
Trading breakouts – the second strategy in our case is shown in the blue square: the price touched the resistance line and then broke it. Accordingly, we should trade against the previous trend by buying CALL options.
The above example is quite relevant since it clearly shows that channeling provides a lot of signals within a short time.
If you like this strategy, you might also be interested in this Hanging Man Candlestick
We have repeated the previous action and have built a channel on four points. At this time, the points show an uptrend.
Trading ranges is quite similar with the descending channel example described above.
Trading breakouts looks the same – you can see that the blue square shows how the price touched the support line and then broke it below. This is the time when you have to buy PUT options and trade against the previous trend.
The rules for determining the price range are identical. We take 4 points – 2 regional highs and 2 regional lows, which at this time draw horizontal lines. Then we buy binary options considering our two strategies – if there is no breakout, we trade within ranges as described in the first case.
Yet, when the price breaks one of the lines, we should trade in the direction of the breakout. In our case, the breakout came on the support line, so we would naturally buy PUT options.
As you could see, channels can offer very accurate signals and may generate a lot of profits if applied correctly.
I will end this channel guideline with two important advices when trading breakouts:
- Check out the volume – increased volume is a more powerful signal that validates the breakouts;
- If you trade on a candlestick chart, you should first consider the breakout candles that are bigger in size than average candles.