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Profiting from Channels

What are channels? In the financial markets, channels are two parallel trend lines formed by connecting the highs and lows of the price action of an underlying asset. Three things must occur for us to properly identify a channel and make a trade through our Forex account.

  1. There must be two trendlines (an upper trend line and a lower trend line).
  2. The trendlines must cut across at least 2 or 3 highs (upper trend lines) or 2 or 3 lows (lower trend lines.
  3. The upper and lower trend line must be parallel to each other.

Channels can be plotted using the channel tool on the MT4 platform, or by independently drawing the upper and lower trend lines, and then visually assessing the trend lines to make sure they are parallel to each other.

There are three types of channels:

  1. Horizontal channels
  2. Ascending channels
  3. Descending channels.

Horizontal Channels

Horizontal channels are very easy to identify on the charts because a trader can plot them using pivot points. You can also use the channel tool on MT4 to plot the channel.

In the chart above, the range of the movement between the trend lines of the channel is about 600 pips.

Ascending Channels

Ascending channels point upwards because they occur in an uptrend, and we see that even though the prices are progressively rising, the range of price movement of the candlesticks are still limited by the channels so formed.

The chart above is a 4 hr chart for the AUDUSD. On this chart, we can see the several points at which a trader can place his buy and sell trades. Over a 3-week period, 6 buy and 3 clear cut sell signals appeared. Even without employing complex technical analysis, a trader can use this ascending channel to generate several trade signals and make good money.

Descending Channels

Descending channels occur in a downtrend and point downwards. Again we see that the range of movement of the candlesticks is limited by the descending channels, even though prices are progressively falling.

In this chart, we can see that there are 3 buy signals and 2 sell signals. Being a daily chart, the pip range is quite large and even if a trader is able to trade 2 signals, this would lead to huge profits.

We need to emphasize here that it is not usually a good idea to place buy and sell signals using the channels alone. The buy and sell signals must be reinforced by the use of indicators like the Fibonacci retracement tool and the Stochastics oscillator that indicated overbought and oversold market conditions. 

Furthermore, my bias for these types of trades is to trade with the trend, in keeping with the saying that the trend is my friend until it ends. So I would typically take the sell signals in a descending channel, and a buy signal when it appears on an ascending channel. When trading the horizontal channels, you can trade both buy and sell signals since the trend at that point in time is indeterminate.

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