Trading Channels

Prices in a classic trend tend to trade roughly within a channel range formed of a support level and a resistance level (See support and resistance guide for basics). A channel can be identified by constructing a line parallel to the major trend line, by connecting the higher highs and lower lows.

Provided the market remains predominantly within the channel, it can be viewed as behaving normally during the trending period. The market will eventually trade outside the channel and can be viewed as a breakout. A breakout in the trend direction can indicate the beginning of an accelerated phase. On the flip side, a breakout in the opposite direction can indicate the end of the trend, as shown in the example below.

Example system

1. Trend Channel Breakout

A trend channel breakout trading system is shown in the chart for Palladium below and works as follows:

• A sell/buy position is entered when the price closes below/above the drawn trend channel. In the first attempted channel break out, as shown below, the entry price for the sell trade would be approximately 670.
• A stop loss is then placed 2 ATR (this technique will be covered later in the Volatility Trading lesson) above/below the sell/buy positions entry price. Again, using the entry price above and an example ATR of 20 the stop loss is set at: 670 + (2 x 20) = 710. For a $100 position risk size, this equates to $0.25 profit per pip (a price move of 0.1 for this market).
• The exit for this system will be based on a 20 day time-based exit. After 20 days, the price falls from 670.0 to 540.0, a profit of 1,300 pips or $325 based on the initial risk.

Summary

• Prices in a classic trend tend to trade roughly within a channel range formed of a support level and a resistance level.
• Trend channel breakouts can signify the end of a trend and can be used as entry points for trades.
• Trend channel break out systems fail when the price fails to break out of the channel