In this lesson we will look at the following:
What is a trend channel, how it works, and how to trade trend channels?
How to draw trend channels.
What are the different types of trend channels?
How to analyze the market with trend channels.
Trend channels are one of the most commonly used tools in technical analysis. They are used successfully by many forex traders but before you start using them successfully, first we will have to learn them and understand what a trend channel is and how we can apply it in technical analysis.
There are three types of channels used in forex trading., Downtrend channel (the price falls), an uptrend channel (the price rises), and a side trend channel (when the market is consolidating). These are the three types of price channels that are used when analyzing a particular financial instrument.
Let’s start with how to draw a trend channel.
How to draw a trend channel (price channel)? To draw a trend channel we must first determine the trend. To determine the trend, we also use trend lines. Once we have determined the trend, whether it is ascending or descending or lateral, then we can draw a trend channel.
How to draw a trend channel (price channel)? To draw a trend channel we must first determine the trend. To determine the trend, we also use trend lines. Once we have determined the trend, whether it is ascending or descending or lateral, then we can draw a trend channel.
Trend Channel in Uptrend.
Table of Contents
To draw an uptrend channel, we must have an uptrend. The price must make higher highs than the previous ones, and higher lows than the previous ones. We take a trend line and connect the tops with it, and with another trend line, we connect the bottoms of the chart.
This is how an uptrend channel is formed in forex trading or as we can call it (an uptrend price channel).
We are on the currency pair EUR USD where we can see an example with an uptrend channel. As you can see to build this trend channel we use 2 trend lines one trend line we draw on the bottom of the price and the other trend line we draw at the top of the price.
Here we can recall the rules for support and resistance. Because each subsequent bottom appears as support, and each subsequent peak appears as resistance.
Downtrend channel
The same rules apply to the downtrend channel as to the uptrend channel, but vice versa. To build a downtrend channel we need a downtrend. The price must make lower highs from the previous one and lower lows from the previous one.
Then we can take a trend line and connect the tops, then put another trend line and connect the bottoms of the instrument. This way these two trend lines form a downtrend channel (descending price channel).
Here we want to share something important: the strategy with the trend channel uses trend lines, and it is very effective, but we can’t only rely on the trend channels. In trading, we must use as many things in our favor. In the following articles, we will learn a lot more useful information.
We are on the currency pair USD JPY where we can see an example with a downtrend channel. In the same way, as with the uptrend channel here we take a trend line and draw it on the tops and a trend line on the bottoms. Now we have formed a downtrend channel.
Here again, we are going through the article on trend lines and support and resistance. Each peak in the downtrend appears to us as resistance and each subsequent bottom as support. See how we already use several things in trend channels, trend lines, support, and resistances.
As we get more into our forex trading we will add more and more things so we can develop our forex strategy.
And let’s add something about the trend and why it is so important. There is a saying trade only following the trend and the trend is our friend.
Remember if the trend line at the top differs significantly from the trend line at the bottom, then we do not have a trend channel. And traders should not try to adjust it according to themselves, but according to the market. When we do not have tops and bottoms to draw a trend channel we have no trend channel.
How do channels work, and how do we use them in our strategy?
We will try to answer this question in detail with a few photos and videos. Trend channels are also widely used by forex traders. With them, you can determine when to enter a trade and when to exit. In the next few examples, we will look at when and how we can use them.
Let’s look at the example. In order to draw a trend line on the tops, we must have at least two tops, in our case we have marked these two tops with letters A and B. The drawn trend line is our resistance line, and it is the upper part of the trend channel.
The same applies to drawing a trend line on the bottom, we still need to have two bottoms, we have marked them with C and D. After we connect and draw a trend line, an upward trend channel is formed.
Once we have determined the trend channel, we can use it for trading. When the price bounces off the lower trend line of the channel we can look for opening a Buy position and when the price reaches or approaches the upper trend line of the channel we can start thinking of closing out our position.
Here is something for more advanced traders. We can open a Sell position when the price bounces off the upper trend line (the so-called trend correction, we will look at it in the following articles). This is the so-called risk trading before we start practicing it., we must first learn to trade following the trend.
Let’s now look at an example with a downward trend channel.
The same conditions apply to the downtrend channel as to the uptrend channel, but vice versa.
To draw the upper trend line of the channel, we must have two vertices and the second vertex must be lower than the previous one. Here we have two points (two vertices) A and B, after connecting them with a trend line, you can see how and the following peaks comply with this trend line. (this is why it is good to learn to draw trend lines correctly).
To complete the trend channel, we must draw the lower trend line, which will be drawn on the bottom of the instrument. In our case, we have marked these bottoms with points C and D. The second bottom must be lower than the previous one. connect them with a trend line we see how the price continues to comply with this trend line in subsequent bottoms.
Since we have a downtrend it is good to start looking for a Sell position in the given forex instrument. Any bounce from the upper trend line we can open a Sell position and we can hold the position until the price reaches the lower trend line of the channel and then we close the position and collect our profit.
In each of the examples, the bottoms and tops are supports and resistances.
It remains to consider a sideways trend channel or so-called consolidation.
The so-called lateral horizontal range can occur when the price of a particular instrument does not have the strength to make a higher high than the previous one or a lower low from the previous one. The lack of price force is also called consolidation or range.
This channel like the previous one we looked at is very common. As we can see in the image we have two trend lines without a slope, one is resistance and the other is support.
And here comes the question of how to trade this range channel (consolidation). We recommend that you do not trade it because it is the riskier of the three types of trend channels
In this case, we have to watch the price to break either the upper trend line of the channel or the lower trend line of the channel, and then wait for a re-test of the broken trend line so that we can open a position in the direction of the breakout.
But the breakouts of trend lines, breakouts of resistances and supports or previous tops and bottoms will be discussed in the following articles.