- Trading channels can be drawn on charts to help see uptrends and downtrends in a stock, commodity, ETF, or forex pair.
- Traders also use channels to identify potential buy and sell points, as well as set price targets and stop-loss points.
- Ascending channels angle up during uptrends and descending channels slope downward in downtrends.
- Other technical indicators, such as volume, can enhance the signals generated from trading channels.
- How long the channel has lasted will help determine the trend’s underlying strength.
In the context of technical analysis, a channel occurs when the price of an asset is moving between two parallel trendlines. The upper berth trendline connects the swing highs in price, while the lower trendline connects the swing lows. The channel can slant up, downward, or sideways on the chart.
If price breaks out of a trading channel to the top, the move could indicate that the price will rally far. For example, the chart below shows a channel and break in Hyatt Hotels Corporation ( H ) stock. If the monetary value breaks below the penetrate of the channel, on the other hand, the dip indicates that more sell could be on the way .
The trade channel technique much works best on stocks with a average amount of volatility, which can be important in determining the measure of profit possible from a trade. For exemplify, if volatility is moo, then the transmit won’t be very big, which means smaller potential profits. Bigger channels are typically associated with more excitability, meaning larger potential profits .
Types of Channels
A channel consists of at least four reach points because we need at least two lows to connect to each other and two highs to connect to each other. Generally speaking, there are three types :
- Channels that are angled up are called ascending channels.
- Channels that are angled down are descending channels. Ascending and descending channels are also called trend channels because the price is moving more dominantly in one direction.
- Channels in which the trendlines are horizontal are called horizontal channels, trading ranges, or rectangles.
image by Julie Bang © Investopedia 2020
buy or Shorting the Channel
Channels can sometimes provide buy and sell points and there are several rules for entering long or inadequate positions :
- When the price hits the top of the channel, sell your existing long position and/or take a short position.
- When the price is in the middle of the channel, do nothing if you have no trades, or hold your current trades.
- When the price hits the bottom of the channel, cover your existing short position and/or take a long position.
There are two exceptions to these rules :
- If the price breaks through the top or bottom of the channel, then the channel is no longer intact. Do not initiate any more trades until a new channel develops.
- If the price drifts between the channels for a prolonged period of time, a new narrower channel may be established. At this point, enter or exit near the extremes of the narrower channel.
During a rising duct, focus on buying near the bottom of the channel and exiting near the top. Be wary of shorting since the vogue is up. For example, an ascend distribution channel is depicted below in NVIDIA Corporation ( NVDA ) shares.
During a derive transmit, focus on shorting near the exceed of the channel and exiting near the bottom. Be wary of initiating longs in a falling channel since the swerve is down .
other forms of technical analysis are sometimes used to enhance the accuracy of the signals from the channel and verify the overall force of the up or down motion. Some early tools to use while channel trade include :
- The moving average convergence divergence (MACD) will often be near zero during horizontal channels. The MACD line crossing the signal line can also point out potential long trades near the bottom of a channel or short trades near the top of the channel.
- A stochastic crossover may also signal a buying opportunity near the bottom of the channel or a selling opportunity near the top.
- Volume can also aid in trading channels. Volume is often lower in channels, especially near the middle of the channel. Breakouts are often associated with high volume. If the volume isn’t rising on a breakout, there is a greater likelihood the channel will continue.
Determining Stop-Loss and Take-Profit Levels
Channels can provide built-in money-management capabilities in the form of stop-loss and take-profit levels. here are the basic rules for determining these points :
- If you have bought at the bottom of the channel, exit and take your profits at the top of the channel, but also set a stop-loss order slightly below the bottom of the channel, allowing room for regular volatility.
- If you have taken a short position at the top of the channel, exit and take profit at the bottom of the channel. Also, set a stop-loss order slightly above the top of the channel, allowing room for regular volatility. Here is a descending channel in BCE Inc. (BCE) along with potential stop-loss and exit points.
Determining Trade Reliability
Channels provide the ability to determine the likelihood of success with a deal. This is done through something known as confirmations. Confirmations represent the issue of times the price has rebounded from the top or bottomland of the transmit. These are the authoritative confirmation levels to remember :
- 1-2: Weak channel (not tradeable)
- 3-4: Adequate channel (tradeable)
- 5-6: Strong channel (reliable)
- 6+: Very strong channel (more reliable)
Estimating Trade Length
The come of time a trade takes to reach a betray degree from a buy point can besides be calculated using channels. This is done by recording the total of time it has taken for trades to execute in the past, then averaging the sum of time for the future. This estimate is based on the assumption that price movements are approximately peer in terms of clock and price. however, it is only an estimate and may not constantly be accurate .
trade channels can look different depending on the time frame selected. For case, a groove on a weekly chart might not be visible on a daily chart.
The Bottom Line
Channels provide one way to buy and sell when the price is moving between trendlines. By “ encasing ” an equity’s monetary value campaign with two parallel lines, buy and sell signals, a well as stop-loss and prey levels, can be estimated. How farseeing the transmit has lasted helps determine the channel ‘s military capability. The measure of time a price normally takes to move from high to moo ( or low to high ) provides an estimate of how long trades may last .