Channel Trading System

Prices often move in channels, when prices rally, they often seem to stop at an invisible ceiling. Also, when they fall, they often seem to hit an invisible floor as well. Traders can use channels to identify buying and selling opportunities and avoid bad trades.

Channels help traders because their boundaries show where to expect support or resistance to come into the market.

Support is where buyers buy with greater intensity than sellers sell. Resistance is, in vice versa, where sellers sell with greater intensity than buyers buy. Channels show where to expect support and resistance in the future.

Construct a channel

There are several ways to construct a channel. Here, let's see the four simply ways.

1. By drawing a channel line parallel to a trendline. The channels parallel to trendlines are useful for long-term analysis, especially on the weekly charts.

2. By drawing two lines parallel to a moving average, one above it and another below. The channels around moving averages are useful for short-term analysis, especially on daily and intraday charts.

3. By drawing two lines parallel to a moving average just the same as above, only the distance between each line and the moving average changes depending on the market's volatility. This kind of channel is well-known as Bollinger bands.

The channels whose width depends on volatility are good for catching early stages of major new trends.

4. By drawing a moving average of the high price of bars and another of the low prices of bars.

Besides the boundaries of a channel, its slope can be used to identify a market's trend. When a channel lies flat, you may trade all swings within its walls. When a channel rises, you should trade only from the long side, buying at the lower bound and selling at the upper bound. When a channel declines, you should trade only from the short side, shorting at the upper bound and covering at the lower bound.

In some kinds of channel, the width of channel depends on the coefficient selected by traders.

For example, a moving average channel can be drawn as follow.

Upper Channel Line = EMA + Channel Coefficient EMA
Lower Channel Line = EMA - Channel Coefficient EMA

However, you need to adjust channel coefficients until a channel contains 90 percent to 95 percent of the price action. As the normal prices should be inside a channel and only unusual events push them outside.

Adjust channel coefficients at least once every three months to make a channel contain 90 percent to 95 percent of prices.

If prices keep bleaching out of a channel and staying outside for more than a few bars, that channel should be widened.

Also, if there are too many reversals within the channel without reaching its boundaries, that channel should be tightened.