A price channel is a state of the market that slopes up or down bounded by a trendline above and below the asset’s price. The upper trend line acts as a resistance to the price, while the lower trend line acts as support. The price channel helps traders maintain the focus on the price alone, unlike the other trading tools, which are plotted directly over the price chart. In an uptrend, as long as the price advances and moves within the channel, the underlying asset trend is considered bullish. The break below the channel line is a sign of the trend being reversed. Two main components of the price channel are the Main Trend Line & the Channel Line.
Main Trend Line – It takes a minimum of two to three points on the price chart to draw the trend line. The line sets the tone for the price slop as well as the trend. To draw a bearish trend line, we need at least three reaction points at the highs. To draw a bullish trend line, we also need two to three reaction lows on the price chart.
Channel Line – After drawing the main trend line, we draw the channel line parallel to the main trend line. For drawing the channel line, we also need two to three reaction highs and reaction lows in accordance with the trend. This channel line also acts as a support in an uptrend and resistance in a downtrend.
Trading Strategies To Trade The Price Channel
Trends + Channel
Channels are perfect to trade the pullback markets. It is advisable to look for the price channel that is sloping at a healthy angle. Don’t try to trade the steep or flat channels as they won’t provide good trading opportunities.
Firstly find a trending market and mark at least two reactions of highs and lows. For taking buy entries, wait for the price to touch the channel line and for selling trades, wait for the prices to touch the main trend line. Remember not to trade both buy and sell opportunities in an up-trending market. This approach is used by amateur traders who fail most of the time as we are going against the flow.
The price chart below indicates the price channel on the AUD/NZD forex pair.
The price gave the first selling opportunity on the 16th of May and the second trade was around 19th May. These trades printed a brand new lower low, and we closed our trades when the prices broke the channel.
Reversals + Channels
In this strategy, we need two timeframes to find accurate trading opportunities. Look for an uptrend on the higher timeframe and then see the same chart on a lower timeframe. On the lower timeframe, let the price to pull back enough. When the prices gave enough pullback, draw the price channel on that pullback. If the prices break below the channel line (in an uptrend) and get knocked back immediately, it is a sign for us to go long. When this happens, we can expect a brand new higher high.
As you can see in the image below, the pair was in an overall downtrend. During the pullback phase, price action tries to break the price channel but get knocked back immediately. It means that some buyers are trying to take the price higher, but the aggressive sellers are grabbing the opportunity to fill a few more orders. After the fake-out, prices held inside the price channel for a bit, and after a few hours, we witnessed a brand new lower low.
Breakouts + Channel
Breakout trading is the most common yet effective approach to take high probability trades. Firstly, find an up-trending market and draw a price channel. Wait for the price to approach any significant level and break below the price channel to take the trade. When the price action goes below the channel line, it is a sign for us to go short. Similarly, in a downtrend, draw the price channel and let the price approach any significant level to take the breakout trade. After the breakout, go long and place the stops just below your entry. If the price holds after the breakout, it is a great sign to take the trade.
The image below represents a sell trade in the GBP/AUD Forex pair. As you can see, the prices were in an uptrend, and when the sellers broke below the price channel, we took a sell trade. We choose a smaller stop-loss order as the channel line also acts as dynamic support to the prices. For booking profits, a higher timeframe support area was a perfect place.
Trading Channels are effective as they provide numerous trading opportunities when the market is moving in that state. You can use all the mentioned ways stated above to trade a channel or use the method that best works for you. When trading, the channel always trade with the trend. Do not over trade whatsoever. If you get used to it, sooner or later, you will blow your trading account. Don’t do this. Instead, always follow the trend. The trend is your friend. Let the market pullback to the channel line to trade with the trend. Another approach is to wait for the prices to break the channel to trade the reversals. These simple approaches are healthier ways to grow your trading account while trading channels. All the best!