In technical analysis, accumulation and distribution zones and trend-lines are most widely used systems. But, there is a system that brings together the elements of trends and zones. It is called Channel.
A channel is defined as the area between two parallel trendlines, and is typically taken as a measure of a trading range.Channel trading is a powerful yet overlooked form of trading that can further maximize a trader’s profits following a particular trend. Just like a trend, channels can be of three types – uptrending channel, downtrending channel and sideways channel. Channels combines trendlines and zones brilliantly to provide a trader with very accurate entry-exit points, stop-loss points and much more!
Channels can appear over a variety of time periods, though it is most popular among short time-frame traders, who follow channels that develop through the course of a single day. That being said, one can easily spot channels that develop over longer periods as well.
The first step in creating a channel is to locate a past distribution zone (swing high) and relative accumulation zone from which to begin the channel. Then just draw two trend lines – one connecting the two highs, and one connecting the two lows. It is important that these two lines should be near parallel.
Channels provide a clear, systematic way to trade. Like said earlier, channels are great to determine when to buy and sell, where to place stop-loss and to books profits. This can be done in following simple ways..
– Buy, or cover shorts when the price hits the bottom of the channel;
– Hold positions when the price is in the middle of the channel;
– Sell your existing long positions and/or go short when price hits the top of the channel.
– If bought at the bottom of a channel: set stop-loss point slightly below the bottom
However, there are some exceptions also to this rule:
– If the price breaks through either of the trendlines, the channel is invalidated, or in other words, channel is broken.
– If price starts drifting within the channel without hitting either trendlines, a new narrower channel might be getting established.
As with most other types of technical analysis, using channels with other technical indicators is a good way to verify their overall strength. A few very useful are:
– MACD: A long entry can be confirmed at the bottom of the channel, if MACD is also giving a buy signal, hence acting as a trade booster.
– Stochastics: Stochastics give excellent confirmation of channel movements.
– Volume: Analyzing vloume ratios can help a trader determine the strengths of channels.
– Candlestick patterns: Very useful for spotting likelihood of channel breakout or channel sustainibilty when price reaches either extreme of the channel.
Therefore, as said at the start, channels are one of the most powerful and accurate methods to trade the market. By encasing price range into two parallel lines, this simple range can provide a trader with exact points from which to buy and sell. This is an extremely useful technique for the trader.
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