What is a channel? Trend channels consist of at least two trend lines that connect the swing highs and the swing lows of a trending or a sideways moving market
It’s a relatively well defined price range that a stock (or other security for that matter) trades within over a period of time. Generally speaking, there is no universally accepted time horizon or percent range that defines a channel. Instead, a channel can be identified when a security often touches a high and low price several times, but does not move outside this range—typically for at least a few weeks or months to be reliable. Chanenls can often reveal potentially important price levels, from a chart analysis perspective.
It’s important to understand that trend channels don’t have to be absolutely parallel and it’s possible that one side of the trend channel is a horizontal support or resistance – in such a case, we typically speak of triangles or wedges. More on this later.
When drawing the trend lines you can use both the wicks and the bodies of the candles- it’s not important to draw perfect trend lines, but more to generally find trend lines that describe price action and trends.
Channels provide a clear and systematic way to trade by providing buy and sell points.
Usually, channels are usually used in 2 different ways:
1) Finding entries once price reaches the trend line and then trading back into the inner channel
2) Waiting for the breakout of the trend line
There is no right or wrong here and both are valid concepts as long as you are aware of some general principles.
When you look for a bounce off a trend line, always wait for a confirmed bounce. Or if you are a breakout trader, you should make trade decisions on the close of a candle. Often, price will just penetrate the trend line and then fall back into the range. Breakout traders could lose a lot of money on false breakouts.
If a stock price breaks through the ceiling of a channel and goes higher, this may be the beginning of a bullish move and might generate a buy signal. Alternatively, if a stock price breaks through the floor of a channel and goes lower, this may be the beginning of a bearish move and might generate a sell signal.
Using Coincident Indicators
There may be times when other forms of technical analysis are needed to enhance the accuracy of the channel trades and verify the overall strength of the channel. Other tools one may use while channel trading often include:
- MACD – During horizontal channels, the MACD will often be near zero. 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.
- Candlestick patterns are also useful for spotting breakouts, as well as turning points within the channel.
The Developing CNX Midcap Channel
The channel forming around the CNX Midcap Index seems to be a well defined one as the attached chart below shows. See the chart carefully and decipher for yourself what you wish to believe may unfold over the next few weeks: A temporary recovery, a disastrous drop or a complete recovery?
The Corridors of uncertainty are yours to negotiate!
Channels provide one way to buy and sell when the price is moving between trendlines. By encapsulating a security’s price movement with two parallel lines, it is possible to generate buy and sell signals, as well as stop-loss and target levels. How long the channel has lasted helps determine the channel’s strength. How long the price usually takes to move from high to low (or low to high) provides an estimate of how long trades may last.