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Using Trend Channels to Find Accurate Entries
07/27/2010 12:01 am EST
When I trade, I always go channel surfing. Not the cable channels, but the chart channels. I surf through my charts looking for channels to watch. Channels are a key element to my trading strategy.
What I call “channel surfing” is looking for a trend in the market, and just like TV channels, market channels are all different. Chart channels can provide you with great trading opportunities.
In order to have a channel, you need boundaries. The market provides support and resistance as those boundaries. Many traders believe that support and resistance are the fundamental elements of all technical trading. These support and resistance lines can help determine future price movements of a currency pair from past movement. I must mention here that historical performance is in no way an indicator of future results. Let's look at the horizontal lines of support and resistance.
In the chart below, you see the blue lines, which represent the horizontal support and resistance lines. The pink circles show where the price interacts with the horizontal lines. This is where the GBP/JPY's price movement upwards hits resistance. There is an equal reaction at the same price level of 140.70 in the last circle. In the blue circle, it is acting as support, keeping the pair up above the horizontal line. Horizontals can act as both support and resistance, as you can see.
In the example, the pair is now trading between 148.44 - 140.70. This is what is referred to as range-bound trading. The pair is stuck in that range. I have a slightly different approach here. I believe the pair is always in a range, even if this range is at an angle.
More often than not, these horizontal lines are prices at which the banks themselves like to trade and they are somewhat hardwired in the system. Now, diagonal lines of support and resistance act differently, but are still support and resistance. Let's look a little closer at the support line of a channel in the chart below.
The GBP/JPY's price is being supported at an upward diagonal. The price is being supported, but not at a standing price like the horizontal Support and resistance lines. The currency pair is being supported as it goes up. The blue circles show where the price and the support line intersect. If you notice, there are large reversal moves as the support intersects with the price. The pair was temporarily falling until it hit the support and then quickly reversed upward as seen below.
The support of the diagonal lines moves with the pair, taking it up or down; in this case upward. Let's look at the resistance line of our channel in the chart that follows.
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The resistant part of this channel is crucial as well. The GBP/JPY's price is being resisted at these pink circle levels. The resistance price isn't stationary as it moves upward along with the pair as well.
At these price levels, the pair reacts with a strong reversal. In a nutshell, the resistance line in a channel contains the trend movement. The resistance keeps the pair from going, in this case, straight up.
These are the basic tools in finding your channel! Your channel will look like the chart below after you have found your support and resistance.
In this particular channel, many traders believe it gives you several buy and sell signals. "Buy on support and sell on resistance." The red dots are sells and the blue dots are buys. The channel tends to work until it is broken. I use this strategy as a basis to my overall trading strategy. You've probably heard the words support and resistance a thousand times, but I hope this gives you a clear understanding and more trading opportunities.
So, even when the market is trending, it's still in a range. The range is just at an angle.
Just keep in mind that these channels are built on areas of support and resistance. There is nothing exact in any of the support and resistances lines, but they are often considered reliable. It is very common for the pairs to temporarily break through these levels before their reversal. The GBP/JPY has had a tendency to break through the support and resistance levels by more than 100 pips before reversing.
Also, a rule of thumb, the larger the time frame, the more dependable the channel, meaning a channel that has been going for three months (daily chart) tends to be a lot stronger than one that's been going for three hours (30-minute chart).
By Joseph Hopkins of TradersChoiceFx.comJoseph Hopkins is a professional trader and is currently a columnist for TradersChoiceFX.com. You can find many more of his articles on the TradersChoiceFX Forex Blog.
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