The Price Channel pattern trading strategy is a smart way of making money online.
It is one of the most easiest and intuitive chart patterns.
In this article, I will be discussing the Price Channel pattern trading strategy in depth.
Let’s start…
What is the Price Channel Pattern?
The Price Channel pattern refers to two trendlines positioned below and above the price action.
The trendline above the price action is referred to as the channel resistance.
The trendline below the price action is referred to as the channel support.
These two lines run parallel to each other.
The price action is then located in between the two trendlines.
For you to draw a channel on a chart, you should look at the price action and try to identify a trending price move in which the tops and the bottoms are moving with the same intensity.
If you are dealing with an uptrend, you can draw a line that goes through the bottoms and another line that goes through the tops, while ensuring that the two lines are parallel to each other.
You will have drawn a channel on your chart.
Consider the following chart…
The above chart shows how you can add a channel to your chart.
Note that the channel has been added to a bullish trend.
The channel support as shown on the above chart is a typical bullish trendline that goes through the bottoms of the price action.
The channel resistance is parallel to the channel support and it connects the diagonal boundary for the topping price action.
That’s how the classic price channel has been created.
So, the channel resistance plays the role of resistance while the channel support plays the role of support.
Consider the following chart…
We have added black arrows to the price channel.
These black arrows point to the support and resistance channel functions on the chart.
When the price decreases to the channel support, it bounces upwards.
The price then seeks interaction with the channel resistance but it bounces downwards.
With the above knowledge, you can use the channel levels to determine the entry and exit points.
If the channel is bullish, look for an opportunity to buy the currency pair as the price bounces from the channel support.
You can then hold the trade until the price approaches the channel resistance.
This way, you will be looking to trade the impulse move of the channel.
If the price bounces from the channel resistance, you can trade the potential bearish move to the channel support.
However, this is not recommended.
The reason is that the corrective price moves are relatively smaller compared to the impulse price moves of a trend.
Channel Breakout
All price trends come to an end, and the price channel is not different.
A channel breakout is said to have occurred when the price action goes through its upper or lower level, then closes strongly beyond that level.
In that manner, the price action exits the channel, and stops conforming within its previous contained structure.
Consider the following chart…
The above chart shows how a channel breakout occurs.
The blue lines show the behavior of the price action within the channel.
Suddenly, the price stops conforming to the channel levels then breaks through the lower level of the channel, the channel support.
This is the channel breakout and it has been marked well in the chart.
The price action cuts through the channel support, which is an indication that the bearish influence on the currency pair is strong enough to interrupt the bullish trend.
A new bearish trend then begins.
The price action enters into a bearish trend, which causes a major price decrease.
After a major decrease in the price, the price action changes direction, creating a new bullish trend.
Although this trend attempts to increase the forex pair’s price, it doesn’t rise to the channel support.
Channel breakouts act as a warning about a termination of an existing trend, and a potential price move in the direction of the break.
The traders can then prepare themselves to enter deals in the direction of the breakout so as to catch a new upcoming price move.
Price Action Trading Using Channels
In Forex, price action channel trading involves trading the inside bounces of the channel.
Additionally, when the channel matures, you can also get ready to trade the breakout, which can lead to a reversal price move.
Consider the graphic given below…
The graphic is an illustration of a price action system using a channel.
The two blue lines running parallel to each other make the price channel.
The line at the top of the price action is the channel resistance, while the line at the bottom of the price action is the channel support.
It begins with a rapid price decrease which creates a bottom marked as 1.
This marks the first point of the above channel.
Next, the price action moves upwards, creating the top 2.
The price action hits the channel resistance and reverses, creating the bottom 3.
The price increases again, stopping at the point 4.
This confirms the channel.
Point 4 gives traders the first trading opportunity on the chart.
Anytime the price action touches the channel resistance for the second time, it creates an opportunity for traders to enter a short trade.
The price kept on bouncing within the price channel, creating two more opportunities for short trades and two opportunities for long trades.
However, since we are dealing with a bearish channel, it will be good for you to trade on the short side, then wait for a channel breakout before looking for a long trade.
In the last opportunity for a short trade in the channel, the price moves downwards but it doesn’t touch the channel support.
The price action reverses in an upward direction and breaks through the channel resistance.
That is the position of the channel breakout.
The price action then creates a close signal for short trade.
However, there is a bullish breakout of the bearish channel, which means that it creates a long signal for a new trade.
After this breakout, the price moves sharply higher.
As a trader, you have two options to exit this long breakout trade.
The first option is when the prices bounces backwards. This has been marked as Close 1 in the graphic.
Secondly, you can close the long breakout trade once the price action breaks the support that was created when it bounced previously.
This has been marked in the graphic as Close 2.
Regardless of the exit option that you use, you will profit from the trade.
Linear Regression Channel
The Linear Regression channel is one of the most popular channel indicators.
The Linear Regression Channel is similar to the standard channel, but it has a middle line, which marks the median price value.
The upper and the lower trendlines are equidistant from the median line.
The median line for the Linear Regression Channel also acts as both support and resistance.
The line can also be used as a trigger to enter trades in the direction of the trend.
The following chart shows this…
The above chart is an example of a standard Linear Regression Channel.
The channel resistance, the channel support and the median line are well shown.
The black arrows added to the channel show the instances during which the price action reacts to the median line as support or resistance.
Once the price bounces from the median line, it returns to where it came from.
Also, when the price breaks the median line, it makes a further move to the opposite channel line.
As a trader, you can use the median line of the linear regression channel as a confirmation for your trades.
You can also use the median line to attain exit signals.
Donchian Channel
This is another type of channel trading indicator.
To calculate the Donchian Channel indicator, you should take the highest high and the lowest low of N periods.
The highs and the lows are marked using horizontal lines, with dynamically changing levels based on the highest high and the lowest low for the progressing periods.
The price action is then encapsulated by the Donchian channel.
This indicator also has a middle line.
This middle line represents the average between the lower and the upper levels of the Donchian channel.
The lower and the upper levels of the Donchian channel also play the support and resistance roles.
However, if the price action begins to hit the upper band continuously, and the price keeps on rising, you get a long signal on the chart.
This is also the case with the lower band. If the price keeps on hitting the lower band of the Donchian channel pushing it downwards, you get a short signal on the chart.
This means that when the distance between the lower and the upper bands of the Donchian channel mare expanded, it gives traders a bias on the price dynamics and the formation of a trend.
You can also use the middle band as a signal to enter or exit a trade.
Consider the chart given below…
The above chart is an example of the Donchian channel.
If you have noticed, it looks the same as the Bollinger Bands indicator.
Indeed, the two are used in the same way.
However, it’s good for you to know the difference between the two.
The Donchian indicator is based on price low and high over x periods, while the Bollinger Bands indicator has a volatility based configuration.
The above chart of the Donchian channel strategy looks chaotic.
However, if you understand how it works, it won’t look chaotic to you.
When the two bands are tight, they act as support and resistance.
This is the phase where the price bounces up and down between the two bands.
It is considered to be a ranging market condition or a consolidation period.
It’s possible for you to trade the bouncing price moves between the two bands, but it’s not the best application of the Donchian trading method.
The most important function of the Donchian indicator is recognizing strong momentum breakouts.
This is seen when the price begins to hit the upper band, moving it upwards or when it begins hitting the lower band, moving it downwards.
This is shown using the black arrows marked as New Highs.
This causes the upper band to begin moving upwards.
This is an indication that the price is increasing with a high intensity, creating a suitable entry in the long trade.
The bands then get tight again. At this point, the price action is testing the lower and the upper bands as support and resistance.
After some time, the price action begins to hit the lower Donchian band, creating lower lows. This has been shown using a black arrow marked as New Lows.
This creates a short opportunity for traders on the chart.
The best place for you to go long would have been where we have the first black arrow on the chart.
This is the position where the price has closed above the previous consolidation level, and is testing the upper Donchian channel, attempting to breakout to the upside.
You can hold the trade until when it makes a serious move to the downwards, which acts as an exit signal for the trade.
Choosing a Channel Trading System
The application of Channel trading on currency pairs is an effective technical analysis technique that can help Forex traders stay on the right side of the market.
Above, we have discussed three channel trading strategies.
So, which one should you use?
You must know that each of these three channel trading strategies is associated with positives and negatives.
For newbie traders, it will be good for you to use the simple price action channel trading method.
Identify a trend, pick the highs and lows of the price action and draw a channel.
Next, trade the bouncing moves inside, probably in the direction of the existing trend.
Also, keep on watching for the breakout move.
The channel breakout is more likely to be followed by a sharp price move in a relatively short period of time.
If you are a very cautious trader and you will always need to get additional confirmation of your channel trading system, it will be good for you to choose the Linear Regression Channel.
Simply identify your two highs and lows then stretch the Regression Channel over it.
Next, look for a bounce from the upper and the lower levels, followed by a breakout through the median level.
If you are more conservative, the median line will provide you with an additional layer of confirmation.
However, you must know that if you wait for the additional confirmation, your potential profit is more likely to be lower on your trade as well.
And, if you feel that you’re a more experienced trader and you need to use a more dynamic, complex, support resistance level, you can choose the Donchian Channel method.
Look for times when the price has broken the recent support/resistance level and begins to hit the lower or upper band, creating pressure in the respective direction.
If the two bands are expanding, enter the trade.
If your trade is implemented properly, and the price continues in the intended direction, then hold your trade until the price action breaks through the middle band in an opposite direction.
Conclusion:
Here is what you MUST NEVER forget…