Channel Trading Strategy- How to effectively trade channels?
A closer look at the price charts often indicates a chaotic mess. For new comers in the field, This is often so true. For experienced traders, who have had enough charting time, The candlestick charts reveals an orderly pattern in the midst of all chaos.
Take this chart below for example.
Most newcomers would have had no clue as to where the stock is heading towards, most would consider this as a bullish trend but most importantly where would you place your entry and exit entries would always be confusion. But a few experienced charting users would sometimes see a major support and resistance forming a channel.
From the chart below it becomes evident that where the previous resistances broke to resume the uptrend.
The chart looks more orderly now and predictable. The chances of having a profitable trade are now much easier.
Trading channels is never that difficult. It all begins with identifying Supports and Resistances. Traditionally, we use horizontal supports and resistances, in a channel we tend to identify support and resistances which are more diagonal in nature. In order to identify a clear support and resistance, the price must touch previous support or resistance twice which must be accompanied by third swing low or swing high.
Both the support and resistances that are formed should be parallel in nature to be considered as a channel. The resistance is the upper bound and the support is the lower bound of a channel.
Upon identifying a channel it becomes easier to track price movements from support to resistance and vice versa. Now this becomes an orderly chart which becomes much more easy to analyse and predict.
How do we effectively trade channels
Within the channel itself, there would exist multiple support and resistances which are minor in nature and becomes more visible on the lower time frames. Some of the common chart patterns that would be commonly seen within the channel are Wedges, Flags. Chart patterns are important within the channel but however they can only serve as an additional rationale for taking the trade. The most important thing that one should keep an eye on is the trade breakout from support or resistance.
To identify the direction of the trade, we must first identify if the channel is bullish or bearish.
In our chart, we clearly see a bullish channel, so we will have to mainly observe 2 important things here, one would be a minor bounce of channel support and second would be a breakout from minor resistance. Once your observations are made, it’s time for entry, exit and stop loss.
Analysing our Entry, Stop Loss and Take Profit
Now that we are in an uptrend, we will only analyse a buy entry.
Entry Position: To find an entry position we must wait for a breakout from the minor resistance level or retest would be helpful. A confirmation of this trade would increase in our favour when a breakout happens above the resistance level. A buy order could be placed over the high of previous candle once it has closed.
Stop Loss: Stop loss is usually placed slight usually below the minor support level which is usually a minor swing low.
Profit Level: Once the price reaches upper resistance level, one can safely book profits as we are looking at a diagonal resistance level, it is indeed hard to predict where the price will stop. There might be occasions as well where price might just stay near resistance level but not touch it.
Channel trading is not a perfect strategy, there are some trades which could fail, however if these strategies are combined with other strategies along with price action, indicators, these setups could well be high profitability set ups.
I am trainer and research analyst at CapitalVeda Financial Research, Apart from writing research reports on technical and fundamental analysis of stocks, I am very passionate to teach and impart knowledge on capital markets to deserving candidates willing to learn and make profits. I am also a farming enthusiast and love to work on real life farming challenges. Enjoy travelling a lot. Trading, Investing and Travelling makes a great career combination. Isn’t it!