The Channel Trading Strategy Explained – Introduction
One of the best things about the financial market is on the number of strategies that can make you money. In the market, there are long-term investors like Warren Buffet who buy and hold stocks for decades. There are also other traders like George Soros who buy and sell securities within a short time. There are also people who use computerized systems to make trading decisions. Among traders, one of the best trading strategies is the use of channels. In this article, I will describe what channels are and how you can trade them to make good returns.
A channel is a pattern that has a series of support and resistance zones. A support is defined as a floor in a currency pair or financial security where the price struggles to trade below. A resistance on the other hand is a ceiling where the price struggles to move above. When the support and resistance continues for a short or long period, it creates a channel. This channel can be either in the diagonal direction or the vertical direction.
To trade using the channel strategy, the first thing you need to do is to find the support and resistance levels. To do this, you are supposed to join two or more extreme levels in a chart as shown below.
Another way to identify channels is using technical indicators. There are indicators that are developed using the foundation of the channel strategy. A good example of such an indicator is the Bollinger Bands. This indicator has three lines. The middle line is the simple moving average of the security within a certain period. The upper band is the SMA for the pair plus the standard deviation while the lower band is the SMA minus the standard deviation. When the price hits the lower band, it is said to be a buy signal and when it hits the upper band, it is known as a sell signal. An example of a Bollinger Band is shown below.
The first strategy to trade the channels is to buy when the price hits the support level and exit when it hits the resistance level. This is ideal when the channel is wide. In case of a narrow channel, buying and selling in support and resistance levels is not ideal because the potential profits will be low. If you use this strategy, you should only be careful about a breakout. To stay safe, you should always have a stop loss for your trades.
The second strategy is where you focus on the breakout. A breakout is a sudden rise or fall of the price in a channel. This happens because no trend lasts forever. When it happens, the trend can continue for a longer period. Therefore, these traders wait for the breakout and then move with the trend. The caution here is on the false breakout. A false breakout is one that happens but fails to hold. For example, when a pair is moving in a horizontal trend, the price could suddenly jump above the support. If it fails to continue, this is said to be a false breakout. To avoid being caught in such a breakout, you should always have a stop loss to prevent more losses.