A price channel is a pattern consisting of parallel trendlines showing two price levels between which an asset’s value oscillates. The channel may be directed upwards, downwards, or sideways depending on market conditions. In TA, traders use channels to identify future price action and establish potential future market momentum.
As mentioned in the previous lesson, price channels represent the combination of two trendlines - where one shows support and the other resistance. These trendlines are confirmed upon the second or third touch. For TA purposes, traders are incentivized to detect channels as it allows them to place stop losses in the respective position above or below the channel, depending on whether they are longing or shorting.
Just like with all other price levels, numerous touches over time weaken the trendline.
If there are six touches on the support line and only three touches on the resistance level, it is likely that the support line is much weaker and that bears have an easier time of pushing prices down. However, such a situation does not have to play out every time, as any sudden change in volume can lead to a breakout in the opposite direction.
A breakout is a term used to describe an event in which prices break out of the channel. Traders can set long or short positions inside the breakout level in order to catch a sudden shift in the market the moment it is confirmed. Do keep in mind that breakout traders are not always lucky as assets may perform a ‘fakeout’ - which means entering the breakout zone and shortly after returning back to the channel.
Traders accustomed to high leverage can make use of channels by identifying one and setting buy and sell orders at future resistance and support levels at lower timeframes. After each entry, the trader can take profit and open a new position in the opposite direction to replicate the results. This process is referred to as day trading on LTFs, and it can be profitable if market conditions are stable.
There are a number of ways to trade price channels. The trading strategy largely depends on the type of the channel, which, as we have previously mentioned are:
This is a type of channel that is trending upwards, meaning that there are higher highs (resistance) and higher lows (support). After determining that such a channel exists, we can buy future lows and avoid unnecessarily buying higher.
For HTF uptrending channels, buying spot is a great approach as we avoid going ‘underwater.’
For LTF uptrending channels, adding leveraged positions is a great move because we minimize any increase to our liquidity level.
If uncertain whether the channel will play out correctly, it is advisable to buy at the breakout level, as shown in the image below.
This is a type of channel that is trending downwards, meaning that there are lower highs and lower lows. Like with an upwards channel, we can avoid unnecessary risk by selling or shorting at the correct levels.
For HTF downtrending channels, selling spot is great because you can distribute your assets over a longer period of time. If any unexpected bullish news happens, you can buy back for a profit or for a neutral balance.
For LTF downtrending channels, adding leveraged short positions is great because we can minimize our liquidity levels by shorting exclusively at the highs.
A sideways channel is a type of channel where prices oscillate between two horizontal trendlines. Both the lows and highs of this channel do not move at all. They typically occur when both bears and bulls are uncertain about what move to take.
Sideways channels are great because they allow you to capitalize on neutral market conditions. You can sell at the highs and buy at the lows for as long as the channel lasts. Such channels can last for days and, in some cases, even longer periods of time, such as a week.
Whether you have bought or sold within the channel, it is possible to avoid losses by placing a stop loss above or below the trend confirmation area (breakout).
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