When it comes to trading, one of the most common strategies traders implement is simply trading between support and resistance areas created by previous volatility in the price of a stock. There are many different types of channels to trade such as Bollinger Bands and Keltner Channels, but this article will solely focus on channels created by support and resistance levels and how traders take advantage of these setups.
What is a Price Channel?
Simply put, a price channel is a set of two trendlines (generally close to being parallel) that move either to the upside, downside, or generally flat within a specific time frame. The direction of the channel is a function of the price action for the particular period a trader is looking at (i.e. an upward channel is created from bullish price action over a specific period of time).
These channels can form on any time frame and can be traded differently based on what type of trader you are. If you are a day trader, you are more likely to probably look for channel setups within the 1 minute time frame up to the 30 minute time frame. However, if you are a longer-term swing trader, you may be looking for channels within the weekly or monthly chart. As each trading strategy is unique, the way a trader uses these channels will vary.
Figure 1: This image shows a very tight downward sloping channel with price action causing this setup.
Figure 2: This image shows an upward sloping channel with price action bouncing off this level 4 times and then breaking to the upside through the Simple Moving Average (50) above.
Figure 3: This image of Delta shows an example of a channel that is trading nearly flat with price staying within a general range of volatility.
One thing to remember when analyzing channels is that each one is unique and is based on the previous volatility over a specific time period (i.e. if a channel on the daily chart has formed, the “width” of the channel is a function of how volatile that time period was). This initial volatility is usually between four points consisting of two support points and two resistance points. These two points (support to support and resistance to resistance) are then connected and the line is then extended creating the appearance of a diagonal or flat rectangle.
Figure 4: This image shows how the current channel was created. Notice how the first four points on the channel really create how wide the chart will be. Traders generally look for channels with large moves between support and resistance to maximize profits.
Primary vs. Secondary Price Channels
As with trendlines, channels can be identified as primary and secondary. This is not always white and black and sometimes this can be hard to find. One thing to note is that the primary channel is the larger channel that price is currently trading in while the secondary channel is essentially catching secondary price action within the primary channel trading area.
Figure 5: This image shows the price trading within two different channels. Notice how the in the most recent price action, the price breaks down through the secondary channel, it is almost certain the price will continue down to touch the primary support below.
Trading the Price Channel
As mentioned previously, one of the most common ways traders take advantage of technical setups in the market is through tests of the top and bottom of price channels. This is usually done through a number of ways but the general strategy is to identify a price channel with two strong areas of support already established and then wait for a third touch to enter. The one thing to keep in mind is that channels can break down at any time so it is important to always be on alert when trading these setups (explore TrendSpider’s dynamic alert system by clicking here).
Figure 6: This image shows a progression of GPRO over a few trading days with the price bouncing off support for a third time with the price moving quickly back to the SMA (50) above.
As with any indicators or technical setups in the market, breakdowns can always occur no matter how big of a buy a stock looks. However, one of the biggest frustrations is selling a stock that selling while a stock breaking down through a crucial level of support and then watching it move right back up to trade towards channel resistance. One thing professional traders will do is always set a stop loss with some percentage cushion (depending on their trading strategy) below the support line price in case market makers try to trigger retail traders to sell. In this case, if their cushion is big enough, they won’t get stopped out.
Figure 7: This chart of SPY shows 3 separate times in which the price broke down through original support line but then immediately bounced right back up.
Optimize your TrendSpider Settings When Looking For Price Channels
One thing to know about TrendSpider is that it is not just an automated software that spits out default trendlines. Changing the settings on the platform can help you find the trendline settings that best fit your style. The current default settings for trendlines will not catch all channels so it is important that you mess around to see which set of inputs finds the ones that you typically look for. In order to do this, follow the steps below.
Figure 8: In order to change settings, click on the button called “Show advanced settings editor” which will show up when you put your mouse over the gear icon.
Figure 9: Once you click on the settings icon, you will be taken to this screen in which you can change the inputs for the trendline settings. This particular input group produces strong channel setups on all time frames.