How to Use Trading Chart Channels to Make Profit and Avoid Loss - dummies

How to Use Trading Chart Channels to Make Profit and Avoid Loss

A trading chart channel is a pair of straight-line trendlines encasing a price series. You can use a channel to help you determine how to make profit and avoid loss in the market. A channel consists of one line drawn along the top of a price series and another line, parallel to the first, along the bottom of the price series.

The purpose of the channel is to train your eye to accept prices within its borders as on the trend and to detect prices outside its borders as off the trend (and perhaps ending the trend). In other words, the channel is a wider measure of trending behavior than a single line. As long as prices remain within the channel, you deduce that the trend is still in place.

When you have confidence that the channel broadly describes the trend, you can

  • Buy near the channel bottom and sell near the channel top. Repeat this process over and over again, as long as the channel lasts.

  • Estimate your future gain. If the width of the channel is $5 and you bought near a support line, your maximum probable gain over the next few days is about $5 — as long as the channel remains in place and you’re able to sell near the resistance line. This is more useful than you may think at first, because

    • It’s a sanity check. You can’t reasonably expect a gain that would call for a price far outside the channel.

    • It’s a reality check. You can use the channel to evaluate a forecast made by someone else. If the forecaster is calling for a price far outside the channel, you have grounds to question the forecast.

  • Calculate your maximum loss. Regardless of where you bought the security, you know that when a price bar breaks the bottom support line of the channel, the channel is no longer valid. The trend is likely over. This is the point at which you want to sell. And you don’t have to wait for the actual breakout. You can place a stop-loss order with your broker at the breakout level.