Channel Trading Can Be A Path To Success

I will break this segment up into a number of lessons, starting here with the introduction.

Channel trading is a powerful form of trading that capitalizes on the tendencies of markets to trend. It combines several methods to provide traders with points where to buy and sell. This discourse will show you how to effectively trade these instruments.

However I wish to point out that this is not a purely mechanical trading system. Although you will have a frame work to trade, you need to use your experience and discretion, mixed with a dash of intuition, to catch the best entry and exit points. Maybe it is best to use this method after you have been trading for some time.

The Character of a Channel

In this context, I will define a channel as the area between two parallel trend lines; this can be taken as a measure of a trading range. The upper trend line connects price peaks (highs) and the lower trend line connects the price lows. We will have a look at examples of channels later in this discourse.

I find that a 2 standard deviation channel is best suited for this purpose, if your charting software allows for that. Incredible Charts can produce such a channel, but I am sure there are others too.

Channels are useful for short to medium term trading - not for long term trading or investing. Channel trading seems to work best on stocks with a medium amount of volatility, but a fairly large range.

Finding a stock to trade

Not all stocks are suitable for this type of trading as it requires that the selected equity has an existing channel in its chart. A channel must have four or more contact points to be considered suitable. I find the best way to locate channels is by physically examining selected charts, perhaps from a previously selected watch list.

Creating a Channel

Channels are fairly easy to create. I will explain first of all how I use the standard deviation channel.

On your charting software, find the lowest low in a 6 months period. If the lowest low is further away, you may have to use 9 months.

Now click on your 2SD indicator and point to the lowest low and drag up to today's price. This will create your channel.

The chart below is an example of a standard deviation channel.

If do not have the software to create an 2SD channel, you can quite easily draw your own channel as follows:

Locate a major high and major low to begin your channel.

Locate another high and low further along to the right of the chart.

Now connect the two highs along the chart with a trend line, and then connect the two lows on the chart with another trend line.

To form a valid channel, these two lines should be reasonably parallel.

You have now your basic channels, with at least two highs forming the upper range of the channel and the two lower points forming the lower range.

Your channels could be horizontal, ascending or descending.

Below we have an example of a horizontal channel. You see that the chart has shown a descending trend, the started to continue to consolidate. We could have recognised the channel at its second low, drawn the lower line and drawn the higher line parallel to it.

This finishes the introduction to channels, on the next page we will look at a strategy to trade the channel.

To be continued soon