Price and trend channels are tools in technical analysis to make sense of charts. Further, trend channels can be used to stay in trades as well as enter new trades. In this article, we show you how you can draw and use trend channels in your trading to have a potentially positive effect on your decision making.
Drawing trend channels 101
Trend channels consist of at least two trend lines that connect the swing highs and the swing lows of a trending or a sideways moving market. It’s important to understand that trend channels don’t have to be completely parallel and it’s even possible that one side of the trend channel is a horizontal support or resistance – in such a case, we typically speak of triangles or wedges as we will see later.
Furthermore, when drawing the trend lines you can use both, the wicks and the bodies of the candles. Here it’s not important to draw perfect trend lines, but more to generally find trend lines that describe price action and the trend waves.
A break of a trend channel is only valid if price closes and stays below the trend line. Just a penetration and wick that goes through the trend line is not enough. That’s why it is mandatory that you only make trading decisions on the candle close.
Stop looking for textbook channels!
We mentioned that it’s not important to find two perfectly parallel trend lines to form a trend channel. Often you find that a market shows you a horizontal support level on the one side and then a trend line on the other side. Or, your trend lines are converging and showing you something like a wedge or a pennant.
A common mistake many futures traders make is that they only look for textbook price patterns. They miss important information about price action and close their eyes for other important clues. Studying and waiting for textbook examples won’t help you make trading decisions in real time because very rarely is the price action you are seeing on your charts as clear as what most textbooks show. This has been our experience after talking to Futures and Forex traders who read book, took course or mentorships.
The screenshot below shows that wicks can often shoot through the trend lines but as long a price closes back into the range, the trend line is still valid. At the same time, very rarely you find parallel trend lines and it’s much more common to see converging trend channels.
Trading price channels, breakouts and fakeouts
Channels are usually used in 2 different ways:
1) Finding entries once price reaches the trend line and then trading back into the inner channel
2) Waiting for the breakout of the trend line
There is no right or wrong here and both are valid concepts as long as you are aware of some general principles.
When you look for a bounce off a trend line, avoid using pending orders and always wait for a confirmed bounce. The biggest problem of trend line traders is that they enter too early and then get caught on a breakout.
When you are a breakout trader, you should make trade decisions on the close of a candle. Often, price will just penetrate the trend line and then fall back into the range. Breakout traders could lose a lot of money on false breakouts.
Trend lines are a tool that can be combined with different types of technical and fundamental analysis. Whether you use them to find range trades during active channels or breakout trades, make sure that you are always waiting for the confirmed break and don’t enter too early on trend lines.
Trend lines are a commonly used tool and the professionals know when the amateurs enter too early around obvious trend lines – then it becomes relatively simple for a professional to squeeze the amateur traders (in our opinion).
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.