Used by traders for technical analysis-based trading, a price channel is a continuation pattern in which the price bounces between parallel resistance and support lines. The resistance and support lines can run horizontal, sloping downwards (bearish), or upwards (bullish). One of the best things about the price channel pattern is that it doesn’t matter if you’re looking at a daily chart or if your long-term trader, this chart pattern works with any trading time frame.
The first line drawn in a price channel chart is called the main trend line. To illustrate this line, an analyst should recognize there need be two lows, in the case of a bullish price channel, and identify two highs, in case of a bearish price channel. The second line drawn in the chart pattern is called the channel line. The channel line requires highs or lows, the quantity of which depends on the analyst – some use two points while others use only one as the price movements runs through the trading channel.
In the case of a bearish price channel, the trend remains bearish if the price decreases while staying within the descending channels lines. Indications of a change in direction include price not meeting the support level. If the price follows the first indication with a move above the resistance, then this is another signal of change. If the price breaks support, then traders can expect a quick decline in price.
The bullish channel is the opposite of the bearish channel. Here the trendlines run through upward ascending channels while the price action remaining within the channels resistant levels. The trend may change if the price does not reach resistance and breaks below the support. Similarly, a break above the resistance is considered bullish. Price channel analysis is a flexible approach to trading as placement of the two trend lines is up to the trader – they may prefer precise price and line connections or tolerate a margin.
Horizontal channels also exist but are much more challenging to spot for traders that are not actively looking for them. A horizontal channel tends to move sideways in a rectangular formation. Buying and seller pressure hits an equilibrium which forces the price movement sideways through to parallel lines. A new high in the price above the upper resistance level represents a buying opportunity. A new low in a price below the lower support level represents a technical sell signal.
What Causes the Price Channel?
A stock or security travels through a price channel when the underlying price is buffered by forces of supply and demand, which can be downward, upward, or sideways moving. The culmination of all these factors pushes the price movement into a tunnel-like trending movement. When there is more supply, the price channel trends downward, when there’s more demand, the price channel trends upward, and if there’s an even balance of supply and demand, the price channel trends sideways.
Traders typically seek out stocks that trade within a price channel. When the stock is trading at the upper end of the price channel, it indicates that the stock will likely trade down back to the center, and when the stock is trading at the bottom of the price channel, it suggests a stock is likely to trend higher.
Price channels are also useful when identifying stocks that are about to break out, which happens when the stock breaches either the upper or lower trendline. If the price action breaks above the upper trendline it is likely that the stock will have a breakout to the upside. If the stock breaks the lower trendline, traders expect continued downward movement.
Trading the Price Channel Pattern
A trader can spot a price channel pattern if they can spot at least two higher highs and higher lows. The trader then draws a line connecting the highs and lows to form the price channel pattern.
It doesn’t matter which price channel you’re working with, once you notice two highs that fail to reach the top of the price channel pattern, the price will soon break downward. Likewise, once you see two lows that fail to reach the bottom of the price channel pattern, the price is likely to break upwards. The larger the gap between the price break in the resistance line, the higher the probability the trade will set up.
Once the price breaks through one of the horizontal channels, the breakout is confirmed. One of the worst mistakes a trader can make is to enter the trade before the price penetrates one of the channel lines. Entering the trade too early can result in the price moving back within the channel, so it’s essential always to wait for the breakout to be confirmed and wait for it to break out above the upper resistance level or break below the lower support level.
Attributes
- Pattern type: Continuation or reversal
- Indication: Bullish or bearish
- Breakout confirmation: The confirmation for this pattern is when the stock or index closes above the upper trendline across the highs or breaks below the lower trendline with above-average volume.
- Measuring: Take the distance between the previous steep move leading into the final push before the breakout, and then add that amount to the breakout.
- Volume: The volume declines and increases during the formation, but it will expand on the breakout.
Conclusion
The price channel tells traders when a stock or index is likely to bounce around within a specific trading range. Once it breaches the upper or lower trendlines, the underlying is expected to have a breakout. On the top side, intense buying pressure will push the stock to achieve higher highs, while a bottom side breach will show weakness, and will push the stock to lower lows. Understanding the price channel allows analysts to determine which dominant force is likely to win out, increased selling pressure, or buying pressure. To learn more about stock chart patterns and how to take advantage of technical analysis to the fullest, be sure to check out our entire library of predictable chart patterns. These include comprehensive descriptions and images so that you can recognize important chart patterns scenarios and become a better trader.
