What Is a Pricing Channel?
It is quite easy to recognize a pricing channel on a chart. To do this, identify a pattern similar to the one below, which shows trading of EURUSD. As you will see, the price is generally falling, but it moves back and forward between two limits. These limits are not fixed, but fall over time to define the channel. Simply connect the highs to define the upper channel limit – the resistance line – and the lower channel limit – or the support line. These two lines should run roughly in parallel if a true pricing channel has formed.
The lower support level is where traders are likely to step into the market to start buying, while the upper resistance level is where they will look to sell to take profits.
Types of Pricing Channels
In the EURUSD example above, the levels are falling, creating a descending channel, but it is also possible for the levels to rise over time, creating an ascending channel. Of course, the levels can be horizontal as well when the security is trading sideways in the market. An example of this type of pricing channel is shown below.
Here, USDCAD moves into a horizontal pricing channel around 22 April and continues to trade in the channel through to 30 April July. Note that the timeframe for this pricing channel is over days, not months as in the previous example. Pricing channels can form over both short and long periods, so it is a good idea to look for them at various different time resolutions.
How to Use a Pricing Channel Step-by-Step
Once you have identified a pricing channel, trading the channel is relatively straightforward. It is very similar to trading a range, since the support and resistance lines are a trigger for trading:
#As the price approaches the upper resistance line, the expectation is that the price will then start to fall – this is the point to sell to take advantage of the anticipated downturn.
#As the price drops further and starts to test the support line, the expectation is that the price will begin to rise again – at which point, this is a buying opportunity to follow the subsequent upwards turn.
When the price is between the two levels, traders generally do not enter or exit the market, which is the same approach that is used with any support and resistance strategy – which channel trading is.
Let’s take a look at this using our previous example. As can be seen from the chart below, the area circled in red is a selling opportunity.
Once one of these selling opportunities occur, you can take advantage of this by doing the following:
1. Enter the market by selling EURUSD. You now have an open position.
2. At the same time, place a stop above the level of resistance. This will make sure that you exit the position quickly if the price continues to rise – breaking through resistance and exiting the channel.
3. Place a limit order at the support level – this is the point at which you expect the price to bottom out and start to rise again. When the limit order is triggered, you have locked in your profits.
The orders you need to place are shown graphically on the chart below.
At this point, wait for the price to rise to the upper resistance level again, at which point there will be another selling opportunity. If the price continues to oscillate within the descending channel for an extended period of time, you will have multiple selling opportunities – each of which can lead to a profit.
On the other hand, with an ascending channel, the trading plan is reversed. The opportunities arise at the lower support line instead of at the upper resistance line. In this case, you should buy at the lower support line, making sure that you have a sell order in below the price so that you will exit quickly in case the price continues to drop.
The time to exit your position in this case is when the price hit the upper resistance line.
What To Avoid
As with any trading plan, you should always have an exit strategy in place when you are trading a channel. Never forget to put in appropriate stop orders to exit your position quickly if the price moves in the wrong direction. It is better to take a small loss than to hope that an unexpected price movement will reverse itself – prices don’t trade in a channel forever. Also, don’t get greedy – take your profits when the price hits the target resistance or support level.
Final Comments
Trading pricing channels is a relatively simple and profitable trading strategy. It is well suited for novice traders because the channel patterns are easy to recognize, and the trading plan is also straightforward. At the same time, it delivers high-probability opportunities for more experienced traders, making it an invaluable tool in their overall trading strategy.
However, as with any trading approach, channel trading does not offer guaranteed profits. Traders need to take the appropriate precautions to minimize any losses and must also exercise trading discipline – they need patience to confirm that the channel has emerged, and need to stick to their trading plan once they have entered the market.