Using Trend Channels to Trade Forex

Using Trend Channels to Trade Forex by Mo4Forex.com

I’ve been learning a lot about trend lines and their significance to my daily trading in Forex. By drawing a proper channel line that the price follows I am able to find possible swing highs and lows telling me I should start to look for possible entries, exits, take profit and stop loss orders. Most trading platforms have a draw channel function, if not, well, I have prepared some examples I’ve recently used myself. Channel lines are drawn on the 3 points, A (high) B (low) C (2nd High) or vice versa in a downward trend. These lines are basically just parallel lines, however, in between there are lines of demarcations at 25% intervals. I’ve noticed that the price action usually fluctuates at these levels more so than at other points, for instance in the second image here, you see the price was on it’s way down from the upper channel and finds support at this middle line. When the price hits the upper or lower channel and can not retrace back to the correlating level, volume has dissapated and/or the trend channel might be broken. I know a few times I’ll draw a trend channel only to have that channel violated with price action that breaks the channel. But, for the most part, I have been able to make quite a few trades that I call, “riding the waves” in between channel lines. 5 to 10 minute scalps that make 10-15 pips (minus spread) 5 or 6 times per pair. This method has its faults I’ve noticed, especially when counter trend trading, as every time I buy into downward market (even on a clear retrace) it is a much “longer haul” than simply trading with the direction of the trend.

To the left is an example of how you can use a Trend Channel and Trend Line to enter a short position in anticipation of the price bouncing off this top trend channel line and reaching the bottom channel within a certain period of time. I simply don’t enter when the price hits this top line, I wait for other conditions to line up together then I get in at a point where I think that trend is over (trend lines help for that). After I get in, I set my stop loss somewhere below the bottom channel and my take profit a little below the upper trend channel line. Depending on the time frame and amount of pips I’m going after, this can take anywhere from 1 minute to days! It all depends, but in this example, I’m looking to make a profit in 15 minutes or less, so I’m trading on a 2 minute chart.

To the right we see how this method actually earned whoever is smart enough to trust it lots of pips in a single day. The last section of this post shows you how this method works on a shorter time frame (all but essential if you want to find the best place to enter or exit). Results will vary based on how patient the trader wants to be. I for one did not ride this short position for too much time, but I wanted to make a note of it because it really is a beautiful thing to behold when it happens. The trend line approach in conjunction with this also helps you find an exit, but in this trade, it was pretty steep price action to be able to draw a viable trend line to the downside here, at least that’s what I felt.

Below is an example of how Trend Channels don’t always work, but probably because of human error. I know for sure this was my own fault because I entered a trade during low volatility hours, and I was counter trend trading, which will always experience more resistance than a position that is with the trend. Even though the price eventually hit the upper channel, it wasn’t before my stops were hit for a loss during a retracement. I was however up 10 pips twice but had my Take Profit at 12 or something, it was a long time ago, but I remember almost turning a profit here.

Example of how trend Channels don’t always work

Another important thing I learned that really does make you money is the use of Trend Channels with Trend Lines. Trend Channel lines can be used with Trend Lines (some use the term Trend Capture Lines), which allow to spot the end of one trend and the begginning of another. Here you see I drew a trend line that on the lows of each bar, and when that line is broken, it’s a good indication that the trend is over; this can work on almost any time frame, including tick charts. Some say more effectively on tick charts, but I’m still trying out both.Trend lines, just like trend channels work on all time frames, but most effectively on longer time frames. It involves drawing a line above or below all the closing prices in a trend. In the example on the left, this is a drilled down version of the channel I was looking at above, we see the price reach the upper channel and at the same time begin to break the trend line. Now, this shouldn’t be an automatic signal to sell, I looked at a few other factors, including volume, time of day, and balance point line. And, if I had just jumped right in, I’d be waiting hours for the price to go in my direction, as light volume couldn’t push the price too far in either direction. If I had been short from that point I’d have to ride out a retracement that might have hit my stops for a loss.

Instead, as we see on the right, I could have waited for the volume to pick up, at which time I’d have to contend with the idea that the price might go back up, to the channel once more, and in truth, there’s nothing that would have prevented it in theory, which is why it’s important to have reasonable stop loss levels when looking to short here. But in reality, what happens is volume picks up more to the sell side and over the next 24 hours the bottom trend line is touched again. Now, when looking for an exit, it would be wise to have a trailing stop based on what ever the situation calls for, and to draw another trend line in the opposite direction, when that line is broken, it might be a good place to sell, especially if it is near the bottom channel. It’s all a matter of how patient I want to be, am I going to freak out every time the trend line is broken for a minute or two, or will I go by what I see and trust the trend? I put in that little comment, this isn’t magic, to remind myself that this should be common sense, the trend is my friend, trend channels help find the trend, trend lines help pinpoint where to find entries and when to exit.