Traders use channels to establish price targets and stop-loss points and identify potential buy and sell points.
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A channel pattern is a chart pattern that combines several forms of technical analysis for identifying trade entry and exit points and controlling risks. A channel pattern is typically seen in the market when prices oscillate between two lines with the same slope. Traders use channels to establish price targets and stop-loss points and identify potential buy and sell points. In today’s article, we will cover the basic characteristics of channel patterns and how to trade using them.
Characteristics of a channel pattern
Typically, channel patterns occur when price moves between two parallel trend lines on an asset. Lower trend lines indicate support and connect swing highs in price, while upper trend lines indicate resistance and connect swing lows. There are three types of parallel lines of resistance and support: falling lines, rising lines, and horizontal lines. When drawn on a chart, these lines always remain parallel to each other and form a channel between them.
Types of channels
Since it takes at least two lows and two highs to connect to one another, a channel must have at least four contact points. In general, there are three types of channels:
- Ascending channels are those that have an upward angle or a positive slope. This pattern develops when a price hits higher highs followed by lower lows. Usually, the price stays between the channel’s support and resistance lines. The trend generally remains bullish as long as prices keep rising and stay within the channel’s confines. On the other hand, prices failing to cross the resistance channel line indicate a forthcoming trend change.
- Descending channels are those that are angled down or have a negative slope. This pattern develops when the price of an asset has lower lows followed by higher highs. As long as prices continue to decrease and trade inside the boundaries of the channel support and resistance lines, the trend will continue to be bearish.
- In horizontal channels, resistance and support levels are depicted by two parallel trend lines drawn above and below the price.
Because prices move more strongly in one direction than in the other, ascending and descending channels are also known as trend channels.
How to trade using the channel pattern
Here are three common rules to follow when trading channel patterns.
- If the price hits the top of the channel, traders should sell their existing long position and/or take a short position.
- If the price hits the bottom of the channel, traders should cover their existing short position and/or take a long position.
- If the price is in the middle of the channel, traders should hold any open trades or do nothing if they have no open positions.
When trading in a rising channel, traders should focus on buying near the bottom and exiting near the top, while when trading in a descending channel, traders should focus on shorting near the top and exiting near the bottom.
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