Today we’re going to talk about trading channels. No, I’m not talking ESPN, the Shopping Channel,nor the Cartoon network for that matter.If that’s what you thought I had in mind,sorry, you’re at the wrong cable company. The channels that I’m referring to are just another price action tool forex traders use to identify areas on the forex chart to buy or sell. And just like the aforementioned channels, they’re fun to watch-That is if you get your trading decisions right.
So what’re we going to do?As usual, we’ll start with a definition, then we look at three types of channels, and finally, VOILA, How to trade these channels.
First and foremost:
What Are Channels?
Well, channels are areas between two parallel trend lines recognized as defined trading zones that traders can buy or sell. Assuming you lay out the channels properly, you should see higher highs and higher highs or lower lows forming. And just so you know,channels are very popular price action tools with forex traders?Why?Because they’re easily recognizable with the naked eye on the forex chart, if you know what you’re looking for.
Now there are three types of forex channels we are going to be looking at. they are ascending channel, descending channel and horizontal channel. I have this gnawing feeling that some of you have already put two and two together concerning these three channels. If that’s true,then you guys are much smarter than I thought.
Anyways,first things first.
What’s an Ascending Channel?
Well the ascending channel is a bullish pattern where the price action is restricted within two parallel ascending trend lines with the price surging upward while ricocheting off higher high and high low price peaks You have an extra trend line running parallel to the right hand side of the main trend line mapping the uptrend line.
Ascending channels come highly recommend because of their spot on prediction of general changes in the uptrend. So long as prices stay within the price channel, the upward trend, led by the bulls continues. However, when prices go beyond the channel, expect to see a strong buy or sell signal. Let’s take a look at what an ascending channel looks like.
As you can see the ascending channel is equipped with trend lines.You have the main trend line with the parallel line keeping company. The higher highs and higher lows represent the bullish trend. Add support and resistance strategies,and you have a great opportunity to enter a trade.
How Do I Draw An Ascending Channel?
First, draw the trend line. Don’t forget that to draw a trend line by connecting two lows. Once you take care of the trend line, draw another trend line,parallel to the first trend line. And make sure it touches the highs created by the price increase. If you’re worried about being Einstein precise when drawing the second trend line?No need.The price will penetrate it regardless of your level of precision.
When drawing the channel at the beginning of the uptrend, look out for two higher lows and one higher high. Connect the two lows with a line and then draw the second parallel line through the higher high. Let’s see an illustration of the drawing.
Notice the two lower lows at the lower end of the right parallel line. Also look out for the higher high along the left parallel line. So long as you’ve got these two scenarios,you have an ascending channel.
How Do I Trade The Ascending Channel?
Put in your trade entry when price touches the lower line(or support level). However,to put in your sell entry,make sure the price touches the upper trend line(or resistance level. Next, llace your stop loss on just outside the channel or just above the high of the candlestick (for a sell order) or just below the low of the candlestick (for a buy order)
Let’s see how it looks like.
As you can see, sell is indicated on the end of upper trend line, and buy at the end of the lower trend line. You’ll be well advised to make sure both buy and sell entries are placed at the exact positions.Anything less,and guess what?Kum ba yah.
Next up is:
What’s a Descending Channel
You don’t need much rocket science to deduce that a descending channel is the complete opposite of an ascending channel. Unlike the ascending channel, the descending line’s price action si contained between two slopping(or downward)parallel lines. And just like ascending channel, descending channels are very useful in establishing whether the short term trend in price will continue. The trend continues only if the price remains within the region defined by the channel.
However, when the price breaks out of the channel, things get real interesting. If price surges upward out of the channel, a signal to buy flashes. When prices heads for the valley outside of the channel, you see a signal to buy. To make a long story short, if the price break out upward out of the channel, the trend is bullish.If price breaks out downwards, it’s a bearish trend. Let’s see what a descending channel looks like
As you can see, the descending channel is made of the two slopping parallel lines and the ensuing price action in between. The price action is considered a channel because the price is trending downwards.
I guess the question burning your minds is:
How do I Draw The Descending Channel?
Make sure you draw the channel parallel to the trend line. Of course you have to establish the downtrend first before laying out the channel. Once you’ve established the downtrend, you draw a parallel line at the same angle as the trend line. You then move the parallel line to touch the most recent low. Please make sure you do this at the same time you draw the parallel line or your account could really suffer. I know, I know, it’s hard doing two things at the same time. But you will be the better for it. this time. Trust me. Let’s look at an illustration
As you can see, the parallel line lie is drawn at the same angle at the trend line. Notice how the parallel line touches the most recent lower low.If you’re into trading ranges, this’ll be the perfect time to go short and put in a sell entry. Just put in your entry at the low peak.
How do I Trade The Descending Line?
It’s no different from the ascending channel. If you want to make a buy or sell entry, you make sure the price touches both trend lines. And just like the ascending channel, you place your stop loss on just outside the channel or just above the high of the candlestick (for a sell order) or just below the low of the candlestick (for a buy order) if it shows signs of rejection.
And last but not least:
What’s a Horizontal Channel
Just like ascending and descending channels, horizontal channels take shape through trend lines that are drawn for both high and low prices on the forex chart. The only difference being that it is flat. The horizontal channel comes about when prices remain the same,or constant over a period of time. And when that happens, the slope of both trendlines takes on a horizontal appearance. Inevitably a horizontal channel is born.
Oh, and lest I forget. The horizontal channel trend lines represent both the support and resistance levels. If prices break out of the resistance level, a buy alert is generated. While a sell signal is generated when prices break out of the support level. However, a horizontal channel is not considered a trend in forex trading circles. Why? because the main players are in consolidation. They’re just taking a breather before resuming hostilities. And the market is moving sideways. Let’s ta look at what a horizontal channel looks like.
As you can see , the horizontal trend lines represents both the resistance and support levels. The three points along the resistance level are labels for the newly formed highs. What you have here is major congestion going on,in that no clear trend has been established. Instead,the major players are taken a breather before resuming their journey. I’d strongly suggest you not trade until a clear trade has been established. Failure to heed this warning could cause you to say” Kum ba yah anybody?”
How Do I Trade Horizontal Channel
- Wait until the resistance level is established at top3.
- Once the resistance level is established at top3, you enter with a sell stop . Make sure you enter your trade on confirmation with a bearish reversal. The candlestick must close before you enter or else?guess what? Kum ba yah.
- Place your stop loss 5-10 pips outside of resistance level. Or place your stop loss 3-5 pips outside the bearish reversal pattern.
- Place your take profit target exactly on the support level.
If You Want To Buy
- Once top3 forms and price moves down to bottom3 at support level, wait for bullish reversal candlestick pattern. Then place your buy order 3-5 pips above high peak.
- Next place your stop loss 5-10 pips outside of support level. Or you can place stop loss 3-5 pips below the low of the bullish reversal pattern.
- Place your profit target a the price level around the support level.
That’s a wrap for “We’re Going to Talk About Trading Channels”. Hopefully you’ve gained a painless understanding on how to trade channels. I hope you all have fun with trading channels whether demo or live.
Til next time take care.
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