How do You Construct a Channel?

You can simply draw one parallel to a trend line, you can do two lines one above and one beneath a moving average. You can also draw two lines, either side of a moving average but these lines will change, with the market volatility which is the theory behind a Bollinger. In terms of currency charts, parallel lines work great on weekly charts and moving averages tend to work better on shorter term time frames. When trading channels, with your trading strategy, look to compare both the daily and weekly charts, to see if you see the same formation, if you do this will add great validity to your trading signals.

Channels in Forex are useful because they will help you generate trading signals with greater accuracy and if used correctly can help you achieve currency trading success – let's now look at the logic behind channels which is rooted in mass trader psychology.

Trading Tips

In terms of channels, prices tend to be fairly valued around a mean price which is a moving average but they will spike up to the top of the channel and to the bottom of the channel. This is where prices are over valued or undervalued and buyers and sellers come in, the channel holds and prices back away from support or resistance. When prices are below the moving average in a channel, you should look to go long and take profits into resistance and sell.

Of course prices can breakout of channels which is the logic of breakout trading but in most instances breakouts fail. Most pro traders, will tend to fade breakouts rather than buy or sell them. Breakouts from flat channels, on increased volatility have a better chance of staying outside support and resistance, than those that are rising or falling steeply.

Traders will always push prices to far from the mean and the top and the bottom of the channel, are great levels of resistance and support to buy or sell into. When a channel is flat and volatility low, then you should simply look to initiate sell signals into the top of the channel and buy into the bottom of the channel. When a channel is rising strongly, you should only be trading the long side and and in a falling market, only trading the short side. This means you are trading with the trend and this will increase the odds of success with your trading signals.

When a channel is rising or falling steeply and volatility is high , then a move outside the channel is likely at some point as prices breakout above support or below resistance. These breakouts can follow through but normally, they will return to the moving average. If you are trading in the direction of the trend, you should be on the right side of these breakouts. On an upside penetration look to sell on a move back to the top of the channel and then wait to get another buy signal on a return to the moving average. The same logic applies in a downward channel and you simply do the reverse.

Final Words

In terms of trading currency markets you can use the above strategy in both periods of trend following and also in periods of consolidation and all you are doing is looking for a return to a mean or average price which is considered fair value. It's a simple trading strategy but if applied with discipline can make great profits.

Your trading system can just be based on price action or you can use candlestick charts and or momentum indicators to help you time your trading signals better. The choice is up to you but any currency trader, should consider this trading system because its simple to learn, the logic is easy to understand and of course, this strategy can be very profitable.