How to trade breakouts using channels

Channels work the same way as trend lines. The only difference is the way they are plotted on the chart. A channel is a combination of both support and resistance lines drawn on the lower and upper side of price movement or trend.

As Price ranges up and down  between the upper and the lower lines of the  channel it can break out on either side of the channel.  So the channel becomes significant when price breaks out of the upper or lower line of the channel.

Just like we mentioned before, channels are formed by two trend lines forming support and resistance levels on either sides at the same time. So you can look at breakout on either direction of the trend.

When price breaks on upper side of the channel, it gives a buy signal and when it breaks the lower line of the channel it gives a sell signal. A broken channel may also result into a change of the entire direction of the trend.

Channels work well in both trending and ranging markets. It can be an ascending channel, a descending channel or a horizontal channel. Let us now look at a few examples;

 Ascending channel

An ascending channel is drawn when price is trending upwards. A breakout on the upper line of the channel/resistance gives a signal for a buy while on the lower level/support gives a signal for a sell.

Ascending channel usually has a bearish bias so breakouts on the downside confirming sell entries perform better than upside breakouts.

Let’s take a look at the chart below.

From our NZDUSD, 30 minute chart above, the confirmation for entry is the bearish candle close below the support trendline. The profit target is is got by measuring the height (H) of the channel and projecting same distance from the break.

Horizontal channel

This forms when price is moving in a side ways direction ranging between levels of support and resistance forming a rectangular pattern. This means price can break either sides of the channel and can form in any kind of the market.

Usually a horizontal channel has no bearish or bullish bias.

A break at a resistance level trendline gives a buy signal and at support level gives a sell signal.

When in an uptrend, a break out at support may lead to a change in direction of the entire trend; trend reversal while in downtrend it is a signal for trend continuation.

When in downtrend, break out on the upper side of  horizontal channel  signals  trend reversal while in an uptrend it signals trend continuation. Therefore a horizontal channel is both a continuation and reversal pattern.

Let’s take a look at an example below on the USDCHF, 15 -Minute Chart

From the above chart,after a breakout on the support level, price rallied strongly to the down side leading to change in the entire direction of the trend.

The sell entry is confirmed by candle close below support line. The profit target is got by measuring height (H) of the channel and projecting same distance to the downside.

Descending channel

A descending channel can be plotted when price is moving in a downtrend. Two parallel falling/descending trend lines are plotted on both sides of the price movement.

Price moves in between finding support and resistance on the lower and upper side of the channel. Price trends down making lower highs and lower lows till it breaks the channel.

The Descending Channel usually has bullish bias

A break out is always expected on the upper side of the channel and this may lead to the entire shift of the whole trend. This gives a strong buy signal.

Let’s take a look at the chart below.

 

From our NZDJPY Daily chart above, the confirmation for buy entry is the bullish candle close above the resistance trendline. The profit target is is got by measuring the height (H) of the channel and projecting same distance from the break to the upside.

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