Technical indicators that identify areas of support and resistance are used in channel trading. This data can be used by traders to decide whether to start a buy or sell position and to gauge the level of market volatility at the moment.
For reference, support and resistance are two different levels that seem to limit the price fluctuations of an item. Support is the point at which the price of an asset may stop decreasing, while resistance is the point at which the price of an asset may stop increasing.
When an asset’s price finds support in channel trading, a trader opens a long position, and they open a short position when the price hits resistance. This is based on the idea that when an asset reaches support or resistance, its price will retrace.
If the price does not burst through to close below support or above resistance, this will only prove to be accurate. If it does, it can be a sign of a trend that is gaining momentum, in which case traders should open a position that supports the trend. If the price is still moving up through resistance, they would take a long position; if the price is still moving down through support, they would take a short position.
It is frequently advisable to wait until a breakout is confirmed by the price closing outside of the channel’s borders at least twice consecutively before trading it. The same goes for many traders, who do not view a channel as confirmed until an asset’s price has encountered support or resistance and retraced at least twice or three times.
How to trade channels?
Trading channels can be done in one of two ways: either by trading the trend, or by trading the breakout after the trend has ended. In order to trade the trend, one must adopt a position that is consistent with the general trend’s direction, such as going long in an ascending channel and short in a falling channel.
While a trend may temporarily retrace its steps, you can also take a position in the other direction, which may eventually result in a more significant trend reversal. If this is the case, you should have entered the trend early to benefit from any long-term price changes that go against the current trend, such as when the price first encounters support or resistance.
Trading the breakout entails taking a position on any price movement that penetrates the channel’s upper or lower band. For instance, you could enter a long position if an asset’s price rises above the channel’s upper band, and a short position if it drops below the channel’s lower band.
Different types of channels
There are three main types of channels we can encounter in trading a security.
Flat channels
Flat channels show that the price of an asset is currently fluctuating within a small or regular band that has equal highs and lows. By locating two to three points of contact between support and resistance within the same broad sideways movement, traders may typically use horizontal channels to confirm a sideways trend.
During a flat channel, traders will frequently choose to go long and short in equal measure, going long when the price meets support and short when it approaches resistance. If the price breaks out and closes above or below, they would act on the presumption that the price will retrace after reaching these levels.
Since many traders believe that the price is more likely to retrace from support and resistance once it has reached those levels in a flat channel than to breakout, it differs from its ascending and declining cousins.
However, because a channel’s upper and lower bands are not always where the price will retrace, it is crucial to take the appropriate precautions to minimize your risk in the event that a breakout happens.
Descending channels
Because the underlying market price is expected to be in a general downward trend, descending channels show that the current trend is bearish. The price graph below demonstrates a descending channel, which is distinguished by a string of lower highs and lower lows.
During a falling channel, traders will sell, either to capitalize on the market’s downward movement or to protect any long holdings they may have in the same market. A trader will most likely open a long position to benefit from price increases once the channel is closed and the underlying’s price starts to rise.
The far right of the channel’s price closed above the level of resistance, as shown in the price chart above, signaling the conclusion of the overall downward trend. With the belief that the falling channel had over and the asset’s price would be ready to undergo an overall rising trend, traders would likely close any open short bets and buy the underlying at this time.
Ascending channels
Because the price of an asset is rising overall, with higher highs and higher lows, ascending channels suggest that the current market trend is bullish. Although an ascending channel is bullish, traders can also sell if the price encounters resistance and reverses course rather than breaking through. The goal of the short position can be to make a direct profit or to protect their long position in the channel from a brief drop in price.
When the price approaches support, traders will initiate long positions in order to benefit from the general price gain. You can use channels in a variety of various timescales, such as by the minute, the hour, the day, or the month, though this is typically gradual.
Once the price has closed above resistance or below support, traders consider an ascending channel to be finished. A trader will probably keep their long position open if the asset’s price moves above resistance. However, if the asset’s price closes below support, the trader will probably start a short position or hold the one they already have if they started it during what they initially believed to be a retracement.
What is the best time frame for channels?
It does not really matter in which time frame we are using channels. The time we can draw a pattern and define the channel, we can use it in trading. We can go long when price is at the bottom line, we can sell around the upper line. In a descending channel we can go short on the upper line and take profit around the bottom line. We can use the hourly, daily, weekly no matter which. But the larger the time frame, the more strength the channel has. A channel drawn in the weekly chart will have much more strength then a channel drawn in the hourly chart.