Trade with Price Channels

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Channel Trading in Forex

Price channels are a trading concept that is borrowed from the traditional trend line concept. Instead of plotting a simple trend line, the price channels comprise of two trend lines, upper and lower trend lines. Trade signals are taken when price breaks out of the upper or lower trend lines or the price channel. When combined with support/resistance methods and candlestick patterns trading price channels offers a great way to trade the markets. It is worth mentioning however that price channels trading requires quite a bit of practice and analyzing the market structure.

There are many different forms of channels that can be used. The most common price channel tools are:

  • Fibonacci Channels
  • Linear Regression Channels
  • Equidistant Channels
  • Standard Deviation Channels

Using the Price Channel Tool

The Price channel is one of the standard tools available in most charting packages. On the MT4 trading platform, the Price channel can be accessed by clicking on Insert>Channels> and selecting one of the channel tools for drawing.

Channels are plotted in the same way as trend lines. This means, two consecutive swing lows or highs are required. For most channel tools such as Fibonacci, Regression Channels and Standard Deviation channels, only two lows or highs are required. For equidistant channels, a low/high/low or high/low/high is required.

The chart above shows how a channel can be drawn.

  • Identify 3 pivot or swing levels (High/Low/High or Low/High/Low)
  • Using the channel tool, connect the two highs or lows and adjust the third point in the channel to the low or high

The Chart below shows the up and down channels and how they are plotted.

Explanation of the different Channel Tools

Fibonacci Channels: The Fibonacci channels require two consecutive lows or highs to be plotted. The channel lines are divided into Fibonacci levels of 0.618 and 1.618. Each of the channel lines represents support/resistance levels.

In the chart above, the Fib channels were plotted with the two lows marked by the arrows. The Fib channels have levels of 0, 1, 0.618 and 1.618. The Fib channels can be adjusted to connect the third channel to an intermediate high (or low).

Linear Regression Channel: The linear regression channel is drawn the same way of connecting two consecutive highs or lows. The linear regression channel then plots the channel to best fit the price and varies from other channel tools.

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Standard Deviation Channels: The standard deviation channels are channels that are plotted based on 1 or 2 (or more) standard deviations specified in the indicator settings. The standard deviation channel is used to measure how much price deviates from the channel (i.e: how many standard deviations).

Equidistant Channels: The simplest of all channel tools, the equidistant channel measures the equal distance within the trend from the highs and lows. The equidistant channel tool makes use of high/low/high or low/high/low pivots to plot the tool.

How to trade using Channels

Channel Trading in Forex allows a better perspective of the market structure compared to merely trading with trend lines. Long and short positions are initiated at the top and bottom ends of the channels, depending on the slope of the channel itself. Alternatively, traders can also be initiated when the channel is broken and successfully retested for support or resistance.

Channels are nothing support and resistance levels plotted in a slope. The chart below explains this in detail. Here, we notice that after using the High/Low/High swing points a down slope or a down trend channel is plotted. Notice how the swing points shows a confluence with past horizontal support and resistance levels.

As price action unfolds, we notice further down the channel of a small retracement towards the upper end of the channel. This offers a good sell opportunity with target booked at the previous support level.

Within the same chart, we also notice how breaks out of the channel only to drop a bit further down to take support from the upper end of the channel. This is a classic channel break out pattern, where a retest of the channel takes place before a new uptrend is established. The chart below gives another example of how the channel break out pattern plays out with a retest of the channel before resuming the uptrend.

Channel Trading Strategy

It is probably best to trade break outs from channels rather than trading within the channel.

To trade the Channel break out, the following criteria is used.

  • Plot a channel connecting high/low/high or low/high/low
  • Wait for price to break out of the channel and to retest the channel
  • Set stops at the low of the channel with entry at the break out price
  • Set target to support/resistance levels formed within the channel

The chart below shows an example of how to trade the channel break out.

  • A channel was plotted connecting swing highs and lows
  • A failed break out to the upside saw price fall into the channel and break out to the downside
  • The break out level shows previous support/resistance level, thus making it a potential area to short on retest
  • Price retest the breakout level and falls to the support levels identified
  • The stops for this trade could be placed at an interim swing high level prior to the break out.

Channel Trading – Summary

Channel Trading in Forex can offer a great way to trade with minimal of indicators. Of course, the signals can be further enhanced by using oscillators such as Stochastics or MACD to confirm the direction of the trade. With due practice channel trading can be an easy way to trade the markets.

Price channels forex

Price channels forex trading has to do with the price action contained between two parallel lines in a trend. A price action is the movement of the price of a security; it includes the use of charts and other forms of analysis in an effort to find some sort of patterns in the movement of price. The parallel lines that contain the price action stand for support and resistance each. Price action in-between the support and resistance line gives rise to price channels in forex.

In forex market, like every other market, there are a lot of orders and demands (being that it is a really liquid market). Sometimes, the demands become higher than the supply, or vice versa, thereby creating a trend direction in the market and affecting the price of the security.

WHAT ARE THE BENEFITS OF PRICE CHANNELS IN FOREX TRADING

With a price channel, you can easily spot a trend, the big picture, which many other traders tend to ignore.

It is possible to identify a regular pattern with price channels. With this pattern, a trader can be guided on how and when to enter a trade or exit a trade.

Studying a price channel can help forex traders understand more about the forex market in general, and are helpful in finding high probability trades

With a price channel, one can detect overbought or oversold levels.

HOW TO READ A PRICE CHANNEL

If you know how to read a price channel chart, you can easily identify strong moves that may result to lasting trend reversal. The lines set above and below the price movement of a security is the price channel. If the price movement of the security moves towards the upper channel, it signifies strength. If the price movement shoots above the upper channel, its strength is said to be extraordinary and can be the start of an uptrend. If the price movement moves towards the lower channel, it shows weakness; if it shoots below the lower channel line, it signifies extreme weakness and could be said to be the start of a downtrend.

THE OVERBOUGHT/OVERSOLD TECHNIQUE IN PRICE CHANNEL

A price channel is used to discover overbought and oversold levels. This can be tricky if care is not taken. Sometimes, when securities are bought, they remain overbought in a strong uptrend. This is same with the oversold situation; securities that are oversold sometimes remain in strong downtrend. This price movement continues not because there is more thrust in the said direction, but because there is a new continuous trend.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

Identify and understand price channels

Price, or trading channels, are a way to visualise trends and ranges on a chart and can indicate levels where the price is most likely going to reverse direction.

What is a price, or trading channel?

Whenever the price of an asset is trading within the boundaries of two trend lines for a prolonged period of time, it is said that the asset is trading within a channel.

A channel can be drawn by either two trend lines or by a channel tool within your charting software. Whichever method you choose to use, it is a manual process to put them onto your chart.

Identifying a price channel

When the price is in an uptrend, it is called an ascending channel.

When the price is in a downtrend, it is called a descending channel.

If the price is ranging within a horizontal support and resistance zone, it is called a horizontal channel.

If there is an uptrend or a downtrend, it means that you can usually draw a channel.

You need to draw two trend lines; one that connects two lows and one that connects two highs. It does not matter if two or more candles pierce through the trend lines, however most of the candles should be within the boundaries.

Why does price stay within a channel?

Channels are essentially a self-fulfilling prophecy and work because many traders have identified them and use them to trade. The more traders that identify a channel, the more the channel will be used to enter and exit trades.

To illustrate this, look at the image to the right, which represents an imaginary asset that has never been traded before – at the beginning, it is priced at $1. Everybody wants to buy it and so the price rises up to $4.5.

You can see in the chart that at the price of $4.5, buyers who bought at $1 may feel that they have made enough of a profit and start to sell. Now that these traders are selling, there is more supply than demand for that asset and the price starts to fall. To secure their profit and avoid losing more in the sudden downtrend, more and more people start to sell and the price falls to, say, $2.

At this price, traders may think that the asset might be cheap again, because they are aware that the asset previously reached $4.5, and so they start buying again.

As soon as the price of the asset reaches $5, traders may decide that the price of the asset is too high, because it previously sold off at $4.5. To secure their profit, they start selling; the price will start to fall again under the new selling pressure. When the asset reaches $2.5, this becomes cheap in comparison to $5 and so traders start buying again.

Traders can now see this price action — the zigzag of the price action shown on the chart. In the image to the right, the zigzag of price action produces the highs number_1 and the lows number_2 and traders use these to draw trend lines; hence the channel is born. A channel can be traded for some time until the fundamentals change and the price breaks out of the channel, which then makes the channel invalid.

Using channels in trading decisions

The easiest way to use a channel for trading is to presume that the asset will stay within the boundaries. You then take a short trade whenever the price touches the upper boundary and a long trade at the lower boundary.

In the chart below, price ranges within the ascending trend lines and forms an ascending channel, thus creating buy and sell opportunities.

  1. Potential sell opportunities
  2. Potential buy opportunities

Another way to use channels in trading is to trade breakouts. In this case, as soon as a candle opens and closes outside the channel, you will take a trade: a long trade when the upper boundary is broken and a short trade when the lower boundary is broken.

In the chart below, the price breaks through the channel to the downside and closes on the outside — this creates a potential sell opportunity.

  1. Price breaks through the channel and closes outside

Price channels are very powerful and traders adhere to them. This means that when the price breaks out of a channel, many of these breakouts could be false. In order to avoid a false breakout, wait for the candle to close outside of the channel before entering, or even wait for a re-test of the trend line.

Using channels in multiple time frame analysis

The third possibility when trading channels is to use them as guidance in multiple time frame analysis. This means that if the asset is trading around the upper boundary on a higher time frame, you can enter short trades on the lower time frames with a tighter stop loss. Likewise, you can enter long trades on a lower time frame when the price is near the lower boundary on the higher time frame.

In the chart below, the channel is confirmed on a higher time frame.

  1. Swing highs and lows confirming the channel
  2. Potential trade opportunities – see below

In the following chart, the same channel is used on a lower time frame to more accurately identify potential buy and sell entry points.

  1. Potential buy entry at the lower boundary of the channel
  2. Potential sell entry at the upper boundary of the channel

Summary

So far, you have learned that:

  • a price channel can be identified whenever the price is trading between two boundaries.
  • there are three types of channels, an ascending channel found in and up trend, a descending channel found in a down trend and a horizontal channels when the price is moving in a range.
  • when a channel is identified, more and more traders use them and so they become a self-fulfilling prophecy.
  • you can find short trades when price touches the upper boundary and you can long short trades when price touches the lower boundary.
  • you can also use the break out of a channel to find trades.
  • you can use channels with multiple time frame analysis to find low risk entries.
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