Trends, which are nothing more than a price and time movement in one direction, are where the idea of price channel trading originates. Price channels provide excellent opportunities to make money irrespective of type of trend and even in case of range bound channel.
Price channels incorporate all of these functionalities, as well as one parallel line to the direction of trend, in the same way that trends provide important information about the overall market direction or the direction of a specific stock, as well as areas of support and resistance in charts.
Table of Contents
- What is a Price Channel
- How To Draw Price Channels
- Types of Price Channels
- Price Channel Trading Strategies
- Strength and Weakness of Using Price Channel Trading
The price channel trading strategy is to use important information provided by price channels to find buy and sell signals with a high probability of profit.
Let us begin with some fundamentals before moving on to the price channel trading setup for profitable trading.
What is a Price Channel
A price channel is the path of price movement and the area enclosed within the boundary of two support and resistance levels, which can also be trendlines.
Price channel represents activity of price movement within some range over a period of time, price channel can only be visible after certain number of contact points are already can be seen in charts usually three touchpoints are necessary to confirm a price channel.
Price channel provide below important information to traders –
- Direction of Trend
- Range of price movement
- Trend reversal
- Volatility of price movements
- Breakout and momentum
How To Draw Price Channels
To draw price channels for trading, first identify if there is a trend by looking at the swing highs and swing lows; if there is, draw a trendline connecting the swing lows for an uptrend and a trendline connecting the swing highs for a downtrend.
Once the trendline is drawn, a line parallel to it is plotted, connecting either swing lows (in the case of a downtrend) or swing highs (in the case of an uptrend).
Like the thumb rule in drawing trendlines a minimum contact points of 3 is required to confirm a price channel in place.
For example, if there is no trend in the market but market swings are within a visible range, draw support and resistance lines that enclose the range of price movement; this is also a price channel formation.
Types of Price Channels
Price channels can be classified into six types based on their construction, trends, volatility, and applications. –
- Bullish Price Channel
- Bearish Price Channel
- Sideways / Neutral Price Channel
- Narrow Price Range Channel
- Wide Price Channels
- Dynamic Channel
1. Bullish Price Channel
The bullish price channel, also known as an uptrend channel, represents market bullishness and is formed by drawing a line parallel to the uptrend line by connecting swing highs.
2. Bearish Price Channel
Bearish price channels, also known as downtrend channels, form during a downtrend.
A bearish price channel is formed by first drawing a downtrend line and then drawing a parallel line connecting swing lows.
3. Sideways / Neutral Price Channel
Because sideways or neutral price channels are neither bullish nor bearish, they are also referred to as neutral price channels.
Sideways price channels are formed by connecting resistance and support levels.
4. Narrow Price Range Channel
Narrow range price channels are price channels in which price movement is within a narrow range; these channels represent a fall in volatility and frequently result in explosive breakouts in either direction.
5. Wide Price Channels
When price swings within a price channel cover a larger area and have a wide range, a wide price channel is formed. A wide price channel indicates greater volatility in price movements.
6. Dynamic Channels
Aside from trendlines, price channel boundaries are formed using standard deviation from the mean (bollinger bands) and average true range from a moving average (keltner’s channels).
The boundaries of such price channels are dynamic and react to price movements.
Price Channel Trading Strategies
Price channels are important price action trading structures that will always be important in any price action trading strategy, regardless of how you use them.
Broadly there are 5 ways to trade price channels-
- Trend Price Channel Trading Strategy
- Reversal Price Channel Trading Strategy
- Trading Ranges with Price channels
- Breakout Price Channel Trading Strategy
- Envelope or Band Price channel Trading Strategy
1. Trend Price Channel Trading Strategy
- Trend following strategy, works best when there is a trend with good slope.
- Only works with uptrend or downtrend channel never use with sideways channel
- Draw uptrend or downtrend channel as per the trendlines.
- Idea behind the strategy is to go along the direction of the main trend and place short entry when prices rise to the upper boundary of a downtrend channel and long entry when prices touch lower boundary of an upturned channel.
- Stop loss is placed above or below the channel boundary depending upon long /short position
- Channel trendlines provide suitable target for this price channel trading strategy
2. Reversal Price Channel Trading Strategy
- When prices move a significant bit from the trendlines of a price channel possibility of trend reversal appears.
- Idea behind strategy is to trade opposite to the direction of major trend when channel breakout happens counter to the trend in place.
- Reversal entry should be placed when there is a sufficient evidence which suggests trend is reversed one way of ensuring it is looking for rejection at the boundary of price channel
- Steep angle price channels are a good candidate for this strategy because steep channels rarely last for a long time.
- Look for a momentum breakout at the price channel’s boundary, which indicates a strong possibility of a trend reversal.
3. Trading Ranges with Price channels
- The first two strategies we discussed were primarily designed for trend trading, but price channel trading can also be used to trade range bound price movements with the same efficiency.
- Range trading is for the sideways/ neutral price channel we discussed in previous section.
- Idea behind the strategy is to take advantage of price channel boundaries which act as support and resistance.
- Using the MACD indicator in conjunction with the price channel boundary, we can place an entry for the oversold and overbought price ranges, and if these price ranges coincide with the price channel boundary, it is a good entry signal.
4. Breakout Price Channel Trading Strategy
- Breakout price channel trading strategy starts where trading range price channel strategy fails due to the breakout of neutral price channel.
- Once a sideways channels is tested many times, it is often seen that support and resistance forming the channel boundaries become weaker.
- To take advantage of the breakout from one of the boundaries of price channel place entry in the direction of breakout.
- Filter out weak breakouts with strong momentum breakouts using volume; breakouts with higher than average volume for the look back period frequently result in price movement in the direction of the breakout.
5. Envelope or Band Price channel Trading Strategy
- Involves the use of bollinger band and kletner’s channels to trade.
- When the price moves to the upper or lower boundary of the bollinger band or the keltner’s channel, an entry is placed.
- The strategy is simple; prices frequently react to channel boundaries and move in the opposite direction if price momentum to break the channel boundary is weak.
- To determine momentum, look for candlestick formations and candlestick patterns at the band’s boundaries.
Strength and Weakness of Using Price Channel Trading
There are no holy grails in trading, just as trendlines and price channels have merits and demerits that must be carefully considered before trading them. The edge of trading lies when price action trading tools are used with their strengths and weaknesses.
- Price channels are easy to draw and provide quick trend analysis, giving a clear idea of trend direction.
- Price channels work well in all timeframes and are used by both traders and investors to analyze major trend directions.
- Price channels offer traders a wide range of trading strategies and options, ranging from breakout trading to range trading.
- Provide information about trend change earlier than indicators or oscillators because price channels are results of direct price action.
- Price channels are prone to whipsaws, manipulations and fake breakouts.
- It is difficult to trade price channels in a volatile market because the swings are often erratic and the risk to reward ratio is not favorable to traders.
- Not all price channels are of equal importance, it is not easy to distinguish ones with larger importance.
- Higher timeframe price channels take a long time to form and are not suitable for short time frame traders, while small time frame price channels do not provide meaningful trading opportunities.
Price Channel Trading FAQ
What are Price Channels?
Price channels are narrow or wide consolidation of price move, and a range bound phase of market.
How To Trade Price Channels?
Wait for price channel breakout and retest the upper or lower boundary of channel and then place the entry in direction of price move.
Is price channel trading strategy profitable?
Price channel trading strategy is profitable way of making money in market, if you know how to analyze price action in general.