Friday, July 6, 2012
Channels occur very often and trading them profitably is presently an area of research. In general, there are three kinds of channels and they are traded similarly from a higher level view but the specifics are different.
Trading Range Channel (TRC): A TRC is a shallow sloped wide-range (3+ points between swings) channel made of large bars (2+ points). The move from the open to about b31 today is a classic TRC. For most traders, TRCs are the most dangerous form of price action. This is because they always appear to be just about to reverse and most of these attempts fail. A new trader may be trapped trying to trade today's AM several times: fBO b5, 2L reversal b9, HL after strong reversal b14, W b19. Note that most of these bars were fairly decent and patterns looked clear. a TRC will trick and frustrate traders over and over. These are dangerous to trade because the stops required are large.
Leg Channel (LC): A leg channel has a slightly steeper slope and usually smaller bars. Most bars are however overlapped and there are many bars with tails. The move from b47-59 is a good example. These are fairly easier to trade since the stops required are smaller. You can enter after any pullback or small bar as long as its near the channel trendline. For example, b50, b55 but not b52 since it was away from the trendline. A small poke beyond a prior bar sets up a 1st channel breakout setup (1CBO). The first BO against the channel is a high probability failure so you should take a trade in the direction of its expected failure. You can also fade the close of the first opposing trend bar (b54).
Trend Channel (TC): A trend channel is actually a regular trend move with very small bars. They appear to overlap but each bar dips only a tick or two below the prior bar implying traders entering aggressively on the close of the prior bar. b59-b64 is a very good example. These can be traded like any strong trend. Enter on the first pullback (b63) or the first opposing strong close (b67) or the first tail in the direction of the move (for example if b64 had a 1t bull body).
Channels types are all related to each other. A TRC is a LC on a higher timeframe, which is a TC on a higher timeframe. TCs in turn are regular trends (such as b65-73) on a yet higher timeframe. Therefore trend strength from weakest to strongest is TRC->LC->TC->Trend.
As you see the price action change from one type to another, it may be an advance notice that a trend is likely to breakout as today or when it moves in the opposite sequence, it may indicate that the trend is about to terminate into a trading range.