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1.
We drew a trend line with two swing highs. The trend line was
sloping downwards.
2.
Then, we drew a parallel line starting with the swing low to complete
the channel.
3.
Prices went up to test the trend line, which is also at the level of a
previous congestion area. Hence, the context was excellent for a
bear trade, so we went short with the bearish inside bar.
4.
The channel trend line provided the perfect price target for this
trend trade.
We could have taken the short trade using only the trend line. However,
having the channel gave us a clear exit point for this trade.
To learn more about trading trends with trend line channels, read Channel
Surfing: Riding the Waves of Channels to Profitable Trading <img
style="border: none !important; margin: 0px !important;" alt=""
src="http://ir-na.amazon-adsystem.com/e/ir?t=tradseturevi20&l=as2&o=1&a=142083312X" width="1" height="1" border="0" />.
TRADING REVERSALS WITH CHANNELS
When price exceeds the channel trend line, it could be a climatic move,
implying that the trend has exhausted itself. We can then look out for
reversal trades like the one below.
<img class="alignnone size-home-top wp-image-2536" alt="The breakout of the channel trend line got rejected by a bullish outside bar, setting
up a bullish reversal trade." src="http://www.tradingsetupsreview.com/wpcontent/uploads/2013/12/Trading-Reversal-With-Trendline-Channel750x396.png?cf9b13" width="750" height="396" />
Reversal trades are usually low probability trades so we must select only
the best trades. Follow these rules to find the best reversal trades.
Ensure that the channel is going against the trend of the higher
time-frame. Effectively, you are looking for a retracement of a larger,
more powerful trend.
Look out for break-out bars with above average bar range. (Read
Yum-Yum continuation pattern.)
For trading strategies that finds break-outs with channels, take a look at:
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade
and how long you should expect the trade to take! Let's look at how these
can be done.
Locating Buy and Sell Points
Channels help locate optimal buying and selling points. Here are the
standard channel trading rules:
When the price hits the top of the channel, sell your existing
position and/or take a short position.
When the price hits the bottom of the channel, add to your existing
position, cover your short and/or buy.
Volume - Analyzing volume ratios can also help you determine the
strengths of different channel movements, which determine the
overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a contact
is made to confirm the change in direction.
If you have taken a short position at the top of the channel, set a
(moving) take-profit point at the bottom of the channel. Also, set a
(moving) stop-loss slightly above the top of the channel, allowing
room for regular volatility (taking the beta into consideration).
2.
2.
Price swung down from above the EMA with eight consecutive
bearish bars.
2.
The seven bars that defined the NR7 bar were all below the EMA,
showing that the bearish momentum held up. Although the NR7 bar
closed higher than its open, it formed a micro triple top with the two
bars before it. After the low of the NR7 bar broke, we went short.
3.
The doji NR7 is also a great example to warn us against using NR7 to
trade reversals without confirmation from other analysis.
The seven bars leading up to the NR7 bar were all below the EMA.
Despite the four bullish bars in the retracement, price could not
reach the EMA.
2.
As price broke the low of the second NR7 bar, we went short.
However, the consecutive NR7 bars was a hint of the tight congestion
that followed.
3.
Price hit our stop-loss at the high of the NR7 bar. It was a false
break-out that reversed and continued the bear trend. Re-entry was a
valid option as price stayed below the EMA throughout the
retracement and our bearish outlook was not compromised.
Toby Crabel studied the NR7 pattern together with the NR4/ID trading
setup. Both patterns are popular trading tools found in many trading
strategies.
(Read: Day Trading with Short Term Price Patterns and Opening Range
Breakout)
In this NR7 trading strategy, we looked for markets with a strong trend
and used NR7 as a low risk entry point to join the trend.
Do not follow the trading rules mechanically. Some NR7 bars appear at the
high of a bull trend or the low of a bear trend. These setups are not the
target of our trading strategy. Wait for a real pullback to enter.
Be very careful when you see multiple NR7 bars. Narrow range bars in
proximity are a sign of price congestion in which NR7 patterns are less
reliable.
Remember to follow the path of least resistance. The best NR7 bars occur
when price is moving against the path of least resistance.
2.
3.
4.
Exit in 7 days
2.
3.
4.
Exit in 7 days
2.
3.
1.
2.
3.
Wait for two consecutive bars to move entirely above the high of the
channel
2.
Buy as price tests the 20 SMA of lows (more aggressive traders can
buy on test of 20 SMA of highs)
Wait for two consecutive bars to move entirely below the low of the
channel
2.
For a conservative trade, we placed a sell limit order at the top of the
channel. As prices spiked up to hit the channel top, we entered a short
position at 1347.25. Prices continued down until 1338 and gave a profit
potential of 9.25 points, while risking almost nothing as the trade went in
our direction immediately after we entered.
In this example, the moving average channel highlighted the strong bear
spike as price moved beyond the channel. The top channel line gave
excellent resistance and minimized our risk. Even if we entered as the
bearish outside bar broke the low of the previous bar, it was still a good
entry with little adverse movement.
LOSING TRADE MOVING AVERAGE CHANNEL DAY TRADE
content/uploads/2014/02/How-To-Draw-Andrews-Pitchfork-750x396.png?
cf9b13" width="750" height="396" />
There are three steps to drawing a Pitchfork.
Step One Pivot Points
You need three points for a Pitchfork.
For a bull channel, label:
2.
Wait for price to fall and test the lower median line
3.
4.
Buy a tick above the high of a bull bar at the lower median line
Short Trade
1.
2.
Wait for price to rise and test the upper median line
3.
4.
Buy a tick below the low of a bear bar at the upper median line
2.
These four points are possible targets for the bear market. In fact,
the last target caught the exact bottom of the crisis.
3.
Price rose strongly and broke out of the upper median line. This
break-out warned us that the market was not simply having a rest in
a down trend. A recovery was underway.
2.
Although the trade achieved more than 1:1 reward to risk ratio, we
consider this trade as a failure because it was a trend continuation
trade. Hence, the most conservative target was the last extreme of
the down trend. Price rose up above our pattern stop at the high of
our signal bar before hitting this conservative target.
3.
After the trend resumed, prices tangled with the median line,
showing that this centerpiece was significant.
The timing of this trade was not perfect, but it was not a bad trade. In
fact, this chart gives us a great opportunity to introduce sliding
parallels.
Sliding parallels are added parallel lines which also act as channel lines.
The first sliding parallel provided excellent resistance in this down trend.
Pick the major pivots. Ensure that the resulting channel is wide. Wide
channels do better and offers a healthier reward to risk ratio.
When drawing Pitchforks, there are two common pitfalls.
The first is selecting the last pivot (point C) too soon. Exercise patience
and let price action confirms the pivot as a major swing point before
including it in your Pitchfork. If not, expect more false signals.
The second problem is with the person with too many Pitchforks. Some
traders are so excited with this new toy that they draw Pitchforks all over
the chart. Its confusing and not helpful.
The basic Pitchfork we used is just a part of a massive trading approach
that includes sliding parallels, trigger lines, multiple Pitchforks, and
variants like Schiff. Most online materials only cover the basic Pitchfork.
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade
and how long you should expect the trade to take! Let's look at how these
can be done.
Locating Buy and Sell Points
Channels help locate optimal buying and selling points. Here are the
standard channel trading rules:
When the price hits the top of the channel, sell your existing
position and/or take a short position.
When the price hits the bottom of the channel, add to your existing
position, cover your short and/or buy.
Volume - Analyzing volume ratios can also help you determine the
strengths of different channel movements, which determine the
overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a contact
is made to confirm the change in direction.
If you have taken a short position at the top of the channel, set a
(moving) take-profit point at the bottom of the channel. Also, set a
(moving) stop-loss slightly above the top of the channel, allowing
room for regular volatility (taking the beta into consideration).
Comments
AA
The S&P 500 SPDR is within a broadening wedge formation since the start
of March, and bounced off the lows of that formation on April 8. A
continued rise in the index toward the highs at $187.70 will favor these
stocks bouncing off their own channel support lines. These four stocks are
all moving within strong trend channels, and currently near channel
support. The support line provides a potential buy area, with the
resistance line top of the channel providing a target.
More Related to this Story
Multimedia
Brocade Communications Systems Inc. channel bounce chart
Multimedia
Covidien channel bounce chart
Multimedia
Qualcomm Inc. channel bounce chart
Multimedia
Consol Energy Inc. channel bounce chart
The targets provided below are based on the current top of the channel.
Over time the channel is rising, so if these trades last weeks or months,
the targets will slowly creep up as the upper channel line rises.
The current trend channel in Brocade Communications has been in place
since December. The stock dipped below $10 briefly on April 7, which was
a test of the channel bottom. So far the channel has held, providing a
buying opportunity between $10 and $10.30. A stop can be placed below
$9.85, with an upside target near the channel top at $11.
Covidien has been moving in a $5 channel (approximately) since October.
The stock is currently falling aggressively toward the lower channel line; if
that selling strength continues, buying isnt recommended. Though, if the
stock slows its decent between $70 and $69, that is a different story. A
pause and then a bounce near the trendline is ideal, providing an entry
between $71 and $70 with a stop below $69. Target is the upper portion of
the channel, between $74 and $74.75.
One thing to be wary of is that the channel is slightly converging, in a
wedge pattern. Wedges are often followed by a reversal. A strong break
below $68.50 indicates this scenario could be underway.
Qualcomm is currently near the middle of its channel, but short-term
momentum is down, signalling the price could soon test the channel
bottom. If the price slows and reverses between $76.50 and $75.75, buys
can be initiated in that area or slightly above. A stop can be placed just
below the newly formed bottom (yet to be determined) or at $75.50.
Target is the top of the channel, which is currently near $81.75.
The trend channel in Consol Energy is less angled than the former stocks
mentioned, indicating a bit more hesitancy on the part of the buyers. That
said, the stock has been swinging well within the channel. Both the upper
and lower channel lines have been penetrated a number of times. That
will make the entry and exit points within stock more subjective, as the
entry and exit areas will be slightly larger than normal.
Currently, the stock is near the middle of the channel, so it may take some
time before an entry signal occurs. The entry area is currently between
$39.50 and $38.50, but that entry area will rise slowly over time. A stop
can be placed below $38.20, or a new low once it develops (yet to be
determined). Target area is $42.10 to $42.65.
Stepping higher (above) shows a typical price channel in the S&P 500
stock index. After setting a low of 1266 on June 8, 2012, the S&P 500
generated a series of higher highs and higher lows the classic definition
of an uptrend. Although relatively short in duration, this is a typical
example of how price trends play out, with surges and retracements that,
when taken together, result in a net move in a predominant direction.
What also is clear is that channels arent always picture perfect. Highs and
lows are fluid, and traders must be alert and flexible as channels develop.
Line drawings
Price channels are simply lines on a chart. They are easy to draw, but its
important to approach the process in a systematic manner:
Identify a consecutive swing high and swing low pair. A swing price
is simply a high (or low) that is surrounded by a defined number of lower
highs (or higher lows) on either side.
After you have drawn the resistance or support line, draw a second
line that connects the opposite extreme of the moves within the trend.
Ideally, this line will be parallel to the resistance or support line that
defines the rate of change for the move.
Like trendlines, the vast majority of channels rise or fall, identifying
uptrends or downtrends. As you might expect, uptrend channels are
considered bullish and downtrend channels are considered bearish.
A driving philosophy of channel trading is that the pattern of consistent
highs and lows will persist. Per this assumption, buy when price nears the
rising support line in an uptrend and book profits when price approaches
the rising resistance line (see On the up and up, below). A common riskmanagement practice in this bullish scenario is to set a stop-loss order
slightly below the support line. More risk-seeking traders also can trade
against the trend selling when price bounces off the resistance line in
an uptrend or buying when prices reacts off the support line in a
downtrend.
Rules to trade by
Although channel analysis helps investors take advantage of price
oscillations, always remember this key rule: When the channel is broken,
its done. Although there are certainly numerous cases of temporary
violations of channel support and resistance levels, dont assume this will
happen. Betting against the break and being wrong can be quite costly.
The channel can re-establish itself, of course, but make no assumptions.
Wait for the swing highs and lows to re-develop and trade off them.
However, that doesnt mean a break (up or down) in the trendline is not a
trading opportunity. When the support line is broken in an uptrend or the
resistance line is broken in a downtrend, it often signifies that the
markets expectation about the stock has changed. This break therefore
can be used to generate a new bullish or bearish bias in the stock. Any
decisive break in the downtrend line is a clear buy signal. Similarly, any
decisive break in the uptrend line is a clear sell signal. In both cases, the
main trendline value should be used as the stop loss.
A break in the opposite channel line, on the other hand, indicates that the
trend is becoming stronger. Traders might consider taking a fresh long
position to participate in the initial euphoria that often follows such a
break, or they can wait for a pullback and establish a new long at a more
favorable price. In either case, keep in mind that breaks are typically
volatile periods, and may be best left to nimble traders with seasoned
risk-control techniques.
An early signal of a coming break might be given when prices fail to reach
a channel line, turning in the middle of the channels width. Such returnline failure indicates that the channel is weakening and investors must be
cautious with their trades when prices revisit the original trendline.
Channels also work well with complementary indicators. Moving averages,
which depict the direction and extent of a trend, and oscillators, which can
reveal intricacies of how quickly, slowly, strongly or weakly prices are
moving within a channel, both are particularly helpful.
Channels are useful for short- to medium-term trading. They are not longterm trading tools. They also work particularly well on stocks with a
medium amount of volatility. However, even long-term traders should be
aware of channel formations. Any violation in this simple price pattern can
foretell significant shifts in market sentiment and profit opportunities
going forward.
1. Right click on an eSignal chart to activate the main menu and select
"Basic Studies" from the menu.
80
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Upper band
Length
Smoothing
B. Buy the extreme price swing at the lower outer linear regression
channel.
C. Place an appropriate trailing stop below the lowest price bar spike
at the lower channel. (The reward potential for the risk taken should be
1.6 or greater.)
2.
E. If the price continues through the median line and approaches the
lower regression channel line, prepare to close the position out as it
exceeds initial expectations.
A. Find a trending stock that has not exceeded the upper channel
until now.
B. Sell the extreme price swing at the upper outer linear regression
channel.
C. Place the appropriate trailing stop above the highest price bar
spike at the upper channel. (The reward potential for the risk taken should
be 1.6 or greater.)
2.
E. If the price continues through the median line and approaches the
lower regression channel line, prepare to close the position out as it
exceeds initial expectations.