What is a Channel?
A channel is also one of the technical analysis tools used by traders to identify a trend and pin points a currency price reversal including a breakout to a new trading level.
As explained earlier on the subject regarding the trends, a channel is simply the price actions of an asset or the currency price being traded over a period of time within a range between the support level and resistance level. It can either be an ascending channel (higher highs and higher lows), a descending channel (lower highs and lower lows) or a ranging channel (horizontal). Channels are very useful for trading as they happen in all time frames and in every types of assets such as currencies, stocks, futures, mutual funds, etc.
An example of an ascending channel
To create a channel, you need to look for three or more tops (peaks) and bottoms (valleys) over a period of time and join them all together by drawing 2 straight lines. Both lines, top and bottom must be parallel and the space between them forms a channel.
As in the trend lines, the top line is the resistance level or ‘return line’ and the bottom line is the support level or the ‘main trend line’.
With all these in mind, a trader can identify when is the best entry points to execute their trade such as placing their trade long when the prices hit the bottom trend line or short their trade when the prices hit the upper trend line. As long as the traders placed their trades within the channel or with the current trend then they are considered safe thus reducing their risks exposure. A trader can even perform multiple trades by repeating the process of shorting his or her trade at the resistance level and go long at the support level until the price actions break out of the channel. Channels are usually good for short and medium term trades but not very effective for long term.
Once the price actions break out of the channel, channeling loses its purpose as a predictive indicator and the trader must then be very cautious and decide whether to close or continue with their trade as it is not possible for it to return immediately.
If it is an upward breakout of a technical channel, that particular trade has turn bullish or bearish if it is a downward breakout, .
When using channel in your forex trading, you must remember the following important points:
- Both trend lines the top line or the resistance level and the bottom line or the support level have to be parallel to each other.
- Usually, the resistance level is considered as the selling zone and the support level is the buying zone.
- The purpose of a channel as a predictive indicator is lost once the price actions break out. When this happens, you have to be cautious and decide on the outcome of your trade whether to close or continue.
- Always draw a channel according to the ‘price actions’ or market directions otherwise it is incorrect.
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