Channels are one of the most common chart patterns that you will find in trading. A channel consists of two trendlines, on the top and on the bottom. These are parallel lines where price fluctuates back and forth. They will provide you profitable trade setups whether the market is trending or not.
The drawing of the channel is pretty simple. Instead of using the trendline technique and drawing trendlines on the top and bottom, we will utilize a different strategy for drawing the channels.
Instead of using the trendline tool and drawing it from wick to wick, we will use the Parallel Channel tool. You will draw the channel where it best fits the price. When placing the channel, try to get as much wicks and bodies of candles to touch.
Looking at the image above, we’ve drawn the channel where the two parallel lines were lined up to touch as much wicks and bodies of candles, on the resistance and the support of the channel.
You will typically find three types of channels in the chart.
A falling channel consists of lower highs and lower lows, with price fluctuating within a consolidation zone called a channel.
Majority of the time, when price breaks out of a falling channel, price will go to the upside.
Here we see a falling channel acting as a trend continuation. Before the channel, price was rising up, then price ‘paused’ by forming a consolidation before continuing the current trend. Falling channels can also act as trend reversal patterns.
A rising channel consists of higher highs and higher lows. Majority of the time, when price breaks out of a rising channel, it will fall to the downside.
Here we see a rising channel in action. Before the channel, price was dropping rapidly, then price ‘paused’ , forming a consolidation called a rising channel before going back down again to continue the downtrend. Rising channels can also sometimes act as a trend reversal pattern.
Flat channel is the third type of channel. Flat channels tend to be neutral in where price will likely go next. When trading flat channels, it’s best to wait till price breaks out of the channel before placing an entry.
Here we see a falling channel breakout in action. When price breaks out of the channel, many times it will do a retest before continuing to the upside. Your profit targets will be where price touched the trendline, with the origin of the channel being the final target.
Same thing for rising channels. Once price breaks through the channel, sell entries are valid and set your final target to be the origin of the channel.
During channel formations, it’s very common for price to form three pushes before eventually going to the opposite trend.
Entering on the third push is a high risk high reward trade. Channels do not always form three pushes, so there is a chance that price could keep going up. However, if you have strong confluence in the trade, entering on the third push can be very rewarding.
For a safer entry, you can wait till price beaks out of the channel to enter. However, you can still take this into account every time you’re trading channels to see where price will likely go next.
A Bump and Run pattern is essentially a channel pattern but has a huge fake out on its last push before going to the opposite trend.
The Bump and Run starts off with a channel formation before shooting up impulsively and shooting down impulsively again. The Bump is a fake breakout from the channel, confusing buyers into buying, before dropping down immediately during the Run.
Here is an example of a Bump And Run. Price consolidates in the beginning, forming a rising channel, price rises up quickly, then melts back down.
Bump And Runs behave similar to channels. When price breaks out, your targets will be the ‘touch’ of the trendlines and the origin point of the channel.
For a higher rate of success of trades and prevent fakes out, what we can do is wait for a break of structure before placing a trade opposite of the general trend.
On the image above, we can see a bearish candle forming at the resistance of the channel. Instead of immediately placing a sell, we will wait until price breaks the previous support structure.
Moments later, we see that price shoots up! If we had placed a sell immediately, we would’ve been in a massive drawdown or stopped out.
Price finally breaks the previous support level, which invalidated the uptrend. Not only do have a broken previous support, we broke through the channel as well, forming a huge bearish candle. After this breakout, you can place a sell.
Seeing the results above, this trade was a great success! By waiting until price breaks structure, we were able to enter with little to no drawdown and have much higher confidence in our trade.