Trend channels and trend lines are powerful tools for trading as they help traders out with various aspects of trading. Here are at least five of them:
- Entering a trade
- Exiting a trade
- Risk management
- Stop loss placement
- Identifying rend & reversal
They offer great value and are multi-functional as you can see. Let’s start with the trend.
Price channels are indicative of trend direction and basically there are two types of price trend channels.
- Bullish or Rising Channel
- Bearish or Falling Channel
Learn how to Trade Bullish Channels
With these types of channels price makes continuous higher highs and higher lows. The lower trend line of the channel acts as support whereas the higher trend line of the channel acts as resistance.
Trading the Bullish Channel:
- Longs are taken at channel support
- Stop loss is placed below the previous low(s)
- Target should be the next channel resistance
The image below shows an example of a bullish channel.
Figure 1: bullish channel example
Learn how to Trade Bearish Channels
In a bearish/falling channel price makes lower lows and lower highs. The lower trend line of the channel acts as support and the higher trend line of the channel acts as resistance.
Trading the Bearish Channel:
- Shorts are taken at channel resistance
- Stop loss is placed at the previous high(s)
- Target should be the next channel support
The image below shows an example of a bearish channel.
Figure 2: bearish channel example
How can Channels Indicate Reversals?
Time frames and channels are an important tool for professional/experienced traders because a channel is not always able to provide support and resistance each time.
At one point price will break below the uptrend channel or above the downtrend channel. The break of the trend channel indicates the start of a reversal or consolidation. The USD/JPY daily chart below shows examples of channel break spots and reversals.
Figure 3: reversal example
Trend Channels and Invalidation Levels:
Sometimes price makes a channel with no false breaks but occasionally price breaks the structure as shown in the chart below. However, price actually did not reverse because the break turned out to be ‘false’.
The false break of the channel can happen. To cater this problem, a previous higher low (In case of bullish channel) should be seen as a point of invalidation and confirmation. If price breaks this level, then the channel is considered finished and completed but price fails to break the support level, then the channel is still active and alive.
Figure 4: false breakout example