A channel is a figure of high reliability, formed by two parallel trend lines at its borders. One connects the price highs, the other the price lows, and in between, there is a zone where the price tends to stay until it breaks. Both trend lines, upper and lower, act as support and resistance. Figure for itself shows the market trend.
There are different kinds of channels, but they mostly work the same way. Let’s see a practical example of each one:
Horizontal Channel:
It can be find either in up or down trends. This doesn’t mean a change of the previous trend, but only a rest in the dominant trend, a consolidation stage before next movement. Most of the time, the break is produced following previous trend.
Bullish channel:
Channels show us the major trend. This does not imply a trend change unless there is a break in the direction opposite to the major trend.
And of course, bearish channels are exactly the same but with the trend going the opposite way. Regarding bullish and bearish channels, remember there is not a fixed number of times a price touches the channels lines, but it's important to know that we need at least 4 points (meaning two maximum and two minimums) to CONFIRM the formation.
For all cases, the target is calculated measuring the distance between both trend lines, and projecting that value the way the break is produced; that could be a minimum target price, where currencies will try to go.
Always remember that both lines must be parallel; different angles will lead to misleading conclusions.
Practical trade with channels
Channels are useful to trade because they show us certain points where reactions should start. When drawn properly, it can assist us to identify areas of support or resistance (determinate by the floor and the roof of the channel). It is a very valuable tool because once a channel is defined we can see many triggers inside it.
But above all trading with channels gives us a very useful strategy, because we have a stop loss defined (maximum loss to afford), and a reliable price target to take profit. Practically, once the price touches the bottom, or floor of the channel, there are good chances that, once the reversion is confirmed, it will try to reach the top or roof of that channel. In the case we choose to wait for a confirmation (something I personally recommend), we can draw a smaller trend line inside the channel, and once this line is broken, we have a signal that the price will try to reach the opposite band of the channel. For this strategy, we have to always remember that if price runs off any extreme of the channel, the strategy loses its efficiency and if we trade properly, then we are sent out of the market by the stop or the limit order. The other possible way to trade channels is by waiting for the break that would eventually happen sooner or later price will leave the channel, and once price action breaks any of these two lines, and confirms with a candle opening the break, we have good chances to see the height of the channel repeated out of it, in the opposite direction. Japanese Yen crosses tend to respect the most this kind of figures.
