A channel forms when the price action of a stock or asset is controlled by 2 parallel, sloping lines. To know how effective the channel lines are, you must make sure that it has tested each of these lines at least twice.
Please note, we are not talking about television channels. These are trend channels drawn on price charts in order to understand price action, sometimes also called price channels.
A parallel uptrend channel slopes up and borders higher lows as well as higher highs in a rising market. Likewise, a downtrend channel slopes down and borders lower highs as well as lower lows during declines.
The area between these parallel channels is known as the trend channel.
An ascending channel as shown above indicates a bullish trend, with the support line connecting consecutive higher lows and the resistance line connecting consecutive higher highs.
The lower line in the parallel uptrend channel is considered as support and the top line is as resistance. The support line of an ascending channel is a buy zone. When price touched the support line, many traders considered buying the security and when price touched the upper resistance line, they book profit.
Likewise, in an established parallel downtrend channel, when price touches the upper resistance line, it’s considered to sell (short) into the downtrend. The lower support line is considered as the target to book profit.
A descending channel as shown above indicates a bearish trend, with the support line connecting consecutive lower lows and the resistance line connecting consecutive lower highs.The resistance line of a descending channel is a sell zone.
Violation of the upper supply line indicates the trend will accelerate or a temporary reversal will take place. If the violation is much steeper, it might be an exhaustion move.
Any failure of the price to hold upper or lower channel lines, signals an important reversal in prevailing trend. Additional confirmation can be obtained from volume. If at the break, we have a high volume, then trend reversal is confirmed.
It’s very difficult to find a perfect parallel trend channel with regular higher highs and higher lows.
We also have a horizontal channel in which trend lines are drawn horizontally, which is nothing but trading in a range or a sideway market.
Remember, you wont get a picture perfect textbook example in the real world. Therefore, getting a perfect price channel where trend lines are drawn parallel to each other is very rare.
In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.
