Range and Trend Channels

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Although, not technically a Technical Analysis (TA) chart pattern, I've opted to place this section here, as it has many of the attributes of chart patterns.  Before reading on it's a good idea to familiarise yourself with Support and Resistance and Why They Matter in Module 1  as range trading is based on these support and resistance levels.  

Trend trading is much more popular than range trading as trend trading is more predictable, allowing profits to run.  Saying that, the Foreign Exchange markets is uniquely suited to both styles.  So, Let's discuss range trading with a Forex example below and continue on to trend channel trading thereafter.  

Ranges and Channels are basically the same thing, with this difference.  A Range tends to be horizontal, where a market is bound by a low price support and high price resistance level.  A channel trends up or down, bound by trend lines formed by lower lows and lower highs or higher highs and higher lows.  However, sometimes Investors will call a horizontal range a channel.  We won't do that here though.

Range Trading

A range trader will adopt a trading strategy trading in a markets consolidation range buying at the bottom of the range and selling at the top.  These ranges can be identified by spotting the peaks and troughs to form trend lines.  It's more risky to range trade then channel trade as ranges tend to be more volatile, with more chance of being stopped out when the trade goes against you.  The trader may repeat the process, as in the below example, of buying at support and selling at resistance many times until the stock breaks out of the channel.  I've differentiated the two types on trading as trend traders and range traders, but in essence they are probably the same person.  

As we discussed in 
Support and Resistance and Why They Matter the upper boundary of the Range is shown by a trend line that connects the points representing a stock's highs over a given time period. Connecting the points representing a stock’s lows identifies the lower boundary of the Range. The downside of this strategy is that when a stock breaks out of the channel, it usually experiences a large price movement in the direction of the breakout. If the breakout direction is not favourable for the trader's position, he or she could lose badly. We would generally place a stop/loss to limit these potential losses. 

Range Trade Example

EUR/AUD Range Trading Example

In the EUR/AUD daily chart above we can see an example of a range trade over a 2 month period.  Within this period the pair has been ranging from 1.2000 to 1.5200.  This is a very simple example and you'd be advised to use other TA when trading, which we'll study in later modules.  Basically a range trader will buy at or near support and sell or short at resistance (As we've explained previously shorting is when you borrow a security from a broker to sell it, hoping to buy it back at a later date at a lower price). 

In our example our trader has established support and resistance, maybe with the help of multi-time frame analysis to view historical support and resistance levels.  As you can see the points don't exactly line up, but we can definitely observe support and resistance zones.   Points 1 and 2 in the chart set our range highs and lows respectively.  Some traders may trade these points having done due diligence, but not knowing what has gone historically, we'll enter the trade on confirmation of the range.  Confirmation of the range occurs at points 3 and 4 where the price hasn't been able to break the previous high and low.  Once confirmation has been established we can start to range trade, selling near resistance and buying near support (Remember to always use other TA to establish confirmations).

Let's look at some individual trades.  A Trader will place a buy order at point 4 (say after the blue engulfing candlestick - see Candlestick Glossary) , thinking that the bottom of the range has been reached, and sell this lot just below resistance at say 1.5000.  Simultaneously, the trader will also place a stop/loss order below what they think is support (say 1.1500).  This stop/loss order is security.  If the trade goes against you, i.e. down, your stop/loss order will limit your losses. We go on to discuss where to place stop/loss in future modules.  Now, if the trader placed a short trade at point 7 (Using the end of an engulfing candle as entry) thinking price would fall he/she would be in for a nasty surprise.  The trade has gone against the trader here, but he/she has had the presence of mind to place a stop/loss to limit any losses at point 8 (1.5520).  In fact the price went up to a previous level of 1.708 before coming back into the range.  Maybe this will be a new resistance level now?

You can see here that this would have been a profitable trading period if out target was the opposite supply/resistance zones.  Let's go through all the trades:
  • Point 3.  Short at and sell at support - PROFIT
  • Point 4.  Buy and sell at resistance - PROFIT
  • Point 5.  Short and sell at support - PROFIT
  • Point 6.  Buy and sell at resistance - PROFIT
  • Point 7.  Sell, but stopped out at point 8 - LOSS
Why The Forex Market is Particularly suited to Range Trading?

It is said that some markets trade a good proportion of the time within a range and this is true of the foreign exchange (Forex) markets. Many Forex traders will adopt range bound trading strategies as cross currency rates tend to be more likely to be bound by a range – particularly non US$ cross currency rates. (Our above chart of Euro/Australian Dollar case in point).  The non USD Forex cross currency rates tend to be less volatile than share and commodity markets, which makes them ideal for range trading.  Typically cross pairs with low interest rate differentials are best suited to range trading, like EUR/CHF.  The USD crosses tend to trend, but not always, so look for yourself at other cross currency pairings to spot suitable ranges, i.e EUR/JPY, GBP/JPY, GBP/CHF, AUD/NZD.  


Trading the Channel

Trading the channels is a trading strategy that identifies stocks trading in trending channels. While in a up trending channel, by finding major support and resistance levels with technical analysis (see Module 1), a trend trader buys stocks at the lower level of support (bottom of the up channel) and sells/short them near resistance (top of the channel). In a down trending channel the trader may also go short (bet against the price) at upper resistance levels and sell their short positions at lower positions within the channel. 

Generally traders are recommended to trade with the trend and you can do so in Channel trading.  Instead of selling at the top of the channel in an up trend or bottom of the channel in a down trend, traders may not sell and let profits run.  Traders may decide to close some of their position, taking partial profits.  The market will run against them for a while, but if you are confident of the trend then the market will turn in your favour before being stopped out.  We'll explore these pull-backs or retracement's in later modules.  

Channel Trading Example

EUR/CAD Channel Trading Example

In the above EUR/CAD daily chart we can see the price has been trending down in a channel.  It's been trending for  quite sometime and this is only a snap shot of the channel.  The theory is the same as range trading, although as mentioned above many traders will only trade with the trend.  Lets say a trade is placed at point 1, once channel confirmation has been established.  In this instance we would short the EUR/CAD at about 1.5000, hoping that price will fall within the channel.  For good money management we're going to place a stop/loss order too outside the channel.  Because trend line drawing isn't an exact science sometimes price overshoots the channel, even though it's still following the trend.  We need to let our trades breathe, therefore place stop/loss on the green line.  

Price did fall, but not immediately to the bottom of the channel.  It reversed to point 2, before hitting point 3 at support.  Point 2 is still within the channel and we've not been stopped out. so we could have added to our short order, or just let it be thinking price will go down.  Support was eventually Reached at point 3.  Our decision here is whether to take all profits by closing the order, take some profit, or to let it run thinking that the down trend channel will continue.  Eventually any of our pen trades would have been stopped out at point 6 and we would have had to start again.

The Inefficient Trade

When trading other Indicators like oscillators will be used before entering and exiting trades.  Without peak and trough analysis and trend lines we may have made an inefficient trade.  Even if it's blatantly obvious we're in a down trend it may take quite some time before we're in profit, or worse still we can get stopped out.  If we placed a short sell order at point 7 thinking price will fall, then we'd probably stopped out losing money.  Even if we hadn't stopped out we wouldn't have been in profit for 2.5 days.  This is fine if you have a very long-term view, but if your horizon is a day or week, then trade timing is critical.

Break-outs

Let me put this out there. I believe utilising trend lines and support and resistance with Price Action is of great trading valueModule 5. Candlestick Chart Patterns & Price Action has more on this. A channel, support/resistance or chart pattern breakout strategy, while maybe having less impressive performance statistics during ‘in sample’ back testing, but will probably show a more robust performance over time. 

The reason that channel breakout systems have stood the test of time is likely because markets trend in the long term and a new multi-month high is always going to have much more psychological significance than the crossing of two arbitrary moving averages, or an under sold stochastic.  My findings strongly support the argument that any system based on predictable market behaviour, is likely to be much more robust than one based on arbitrary mathematical algorithms.

Support & Resistance as part of Range Trading

Identifying Support and Resistance is fairly straight forward enough to do on all chart timeframes IMHO. The key is the price reaction at those areas. At it's simplest anytime there's a rally the base of the rally can be called Support on the chart, Buyers supported that area by buying. Vice versa for selling. The more times the support/resistance area is retested the more valid your support/resistance is. Please note that I see Support/Resistance as areas and not one price.

I find the harder part to my trading is to know how to trade that support/resistance. There's always the old chestnut of "Buy at Support and Sell at Resistance" but you never really know if it's support until after you've bought and there's also the chance that support won't be fully tested so you're not in a position to buy. Maybe It should read "Buy at or near Old Support and Sell at or near Old Resistance" but I do believe that it's the best place to buy or sell as it gives me natural areas in which to place stops i.e. under said support if buying.

To help get a feel for market direction I look at the price reaction at those support/resistance areas that I've identified. If I see the market go up 70 points in 2 days from the support area and at resistance only goes down 20 points in 3 days. I'd say that demand was present at support but didn't see supply present itself in such a fashion at resistance. Therefore my outlook for that timeframe would be more bullish than bearish. I would feel more comfortable buying at/near support than selling at/near resistance. I also find that timeframes are very important to my trading as what often appears to be a major support area on a daily chart might be nothing more than a correction on a weekly/yearly chart. The longer term support/resistance areas are most important to my trading. e.g. Support on a 5 minute chart is nowhere near as important as on a yearly chart. If support/resistance areas tie up on more than one timeframe then you have a tradable market IMHO. For each timeframe I decide whether I'm Bullish, Neutral or Bearish and it's often the case that I'm Bullish on the weekly chart and Bearish on the daily chart for the same equity.

I personally find that once the resistance area is broken a very profitable area to enter long is at the retest of that old area, hence the adage "Old resistance becomes new support" and vice versa for Resistance. There's a number of questions that need to be answered when I trade off support/resistance and as with anything the more I trade the better/more confident I get at answering them. I'd also say that my approach is very subjective and I have to make many "Judgement Calls" on what I see around the support/resistance areas. I would love to find a non-subjective system but have yet come across anything which does not require the trader to use his/her judgment when deciding to buy/sell.

I hope this helps, Dan



To Sum Up

The key to profiting is accurately identifying and exploiting these trends in real time, which can be more difficult than it sounds. As a result, it is wise to trade this technique with a practice account - as it is any new technique you are learning - before going live. And, remember to use stop/loss to limit your losses.  As with the above trading example, even though the market price went higher, it took several months to reach the target.  A judgement call needs to be made on whether to continue the trade, or sell it.

Technical analysis is not an exact science and although these indicators and patterns can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

Simple Range Trade System

Chart Set Up: Identify important support and resistance levels on the hourly chart. Most good charting packages do this job for you, but it's possible to do it yourself with screen time.

Add the Stoch (5,3,3) oscillator to your chart to pinpoint possible long and short entries in the market.


Execution 

1. Wait either for a pull back towards support or a rally towards resistance.

2a. For long trades: Go long if price touches support and reverses long with a positive stoch cross from below 20 (see chart above) 

2b. For short trades: Go short if the price touches resistance and reverses with a negative stoch cross from above 80.

3.  A stop loss is set just  below the most recent level of support @ 0.8314. 

4. Target is just below resistance 

As we can see from the chart AUD/USD price touches a significant support level and goes back up. (AUD/USD holds support). The gray circle indicates the time to go long in the market @ 0.8365 (Stoch cross from below 20).

NB. This is a simple set up and system. Extensive testing in your market with an appropriate reward to risk ratio is needed and once again other T.A. should be used to confirm price reversal, i.e candlestick patterns. We go on to talk about these later in the resource



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Although, not technically a Technical Analysis (TA) chart pattern, I've opted to place this section here, as it has many of the attributes of chart patterns.  Before reading on it's a good idea to familiarise yourself with Support and Resistance and Why They Matter in Module 1  as range trading is based on these support and resistance levels.  

Trend trading is much more popular than range trading as trend trading is more predictable, allowing profits to run.  Saying that, the Foreign Exchange markets is uniquely suited to both styles.  So, Let's discuss range trading with a Forex example below and continue on to trend channel trading thereafter.  

Ranges and Channels are basically the same thing, with this difference.  A Range tends to be horizontal, where a market is bound by a low price support and high price resistance level.  A channel trends up or down, bound by trend lines formed by lower lows and lower highs or higher highs and higher lows.  However, sometimes Investors will call a horizontal range a channel.  We won't do that here though.

Range Trading

A range trader will adopt a trading strategy trading in a markets consolidation range buying at the bottom of the range and selling at the top.  These ranges can be identified by spotting the peaks and troughs to form trend lines.  It's more risky to range trade then channel trade as ranges tend to be more volatile, with more chance of being stopped out when the trade goes against you.  The trader may repeat the process, as in the below example, of buying at support and selling at resistance many times until the stock breaks out of the channel.  I've differentiated the two types on trading as trend traders and range traders, but in essence they are probably the same person.  

As we discussed in 
Support and Resistance and Why They Matter the upper boundary of the Range is shown by a trend line that connects the points representing a stock's highs over a given time period. Connecting the points representing a stock’s lows identifies the lower boundary of the Range. The downside of this strategy is that when a stock breaks out of the channel, it usually experiences a large price movement in the direction of the breakout. If the breakout direction is not favourable for the trader's position, he or she could lose badly. We would generally place a stop/loss to limit these potential losses. 

Range Trade Example

EUR/AUD Range Trading Example

In the EUR/AUD daily chart above we can see an example of a range trade over a 2 month period.  Within this period the pair has been ranging from 1.2000 to 1.5200.  This is a very simple example and you'd be advised to use other TA when trading, which we'll study in later modules.  Basically a range trader will buy at or near support and sell or short at resistance (As we've explained previously shorting is when you borrow a security from a broker to sell it, hoping to buy it back at a later date at a lower price). 

In our example our trader has established support and resistance, maybe with the help of multi-time frame analysis to view historical support and resistance levels.  As you can see the points don't exactly line up, but we can definitely observe support and resistance zones.   Points 1 and 2 in the chart set our range highs and lows respectively.  Some traders may trade these points having done due diligence, but not knowing what has gone historically, we'll enter the trade on confirmation of the range.  Confirmation of the range occurs at points 3 and 4 where the price hasn't been able to break the previous high and low.  Once confirmation has been established we can start to range trade, selling near resistance and buying near support (Remember to always use other TA to establish confirmations).

Let's look at some individual trades.  A Trader will place a buy order at point 4 (say after the blue engulfing candlestick - see Candlestick Glossary) , thinking that the bottom of the range has been reached, and sell this lot just below resistance at say 1.5000.  Simultaneously, the trader will also place a stop/loss order below what they think is support (say 1.1500).  This stop/loss order is security.  If the trade goes against you, i.e. down, your stop/loss order will limit your losses. We go on to discuss where to place stop/loss in future modules.  Now, if the trader placed a short trade at point 7 (Using the end of an engulfing candle as entry) thinking price would fall he/she would be in for a nasty surprise.  The trade has gone against the trader here, but he/she has had the presence of mind to place a stop/loss to limit any losses at point 8 (1.5520).  In fact the price went up to a previous level of 1.708 before coming back into the range.  Maybe this will be a new resistance level now?

You can see here that this would have been a profitable trading period if out target was the opposite supply/resistance zones.  Let's go through all the trades:
  • Point 3.  Short at and sell at support - PROFIT
  • Point 4.  Buy and sell at resistance - PROFIT
  • Point 5.  Short and sell at support - PROFIT
  • Point 6.  Buy and sell at resistance - PROFIT
  • Point 7.  Sell, but stopped out at point 8 - LOSS
Why The Forex Market is Particularly suited to Range Trading?

It is said that some markets trade a good proportion of the time within a range and this is true of the foreign exchange (Forex) markets. Many Forex traders will adopt range bound trading strategies as cross currency rates tend to be more likely to be bound by a range – particularly non US$ cross currency rates. (Our above chart of Euro/Australian Dollar case in point).  The non USD Forex cross currency rates tend to be less volatile than share and commodity markets, which makes them ideal for range trading.  Typically cross pairs with low interest rate differentials are best suited to range trading, like EUR/CHF.  The USD crosses tend to trend, but not always, so look for yourself at other cross currency pairings to spot suitable ranges, i.e EUR/JPY, GBP/JPY, GBP/CHF, AUD/NZD.  


Trading the Channel

Trading the channels is a trading strategy that identifies stocks trading in trending channels. While in a up trending channel, by finding major support and resistance levels with technical analysis (see Module 1), a trend trader buys stocks at the lower level of support (bottom of the up channel) and sells/short them near resistance (top of the channel). In a down trending channel the trader may also go short (bet against the price) at upper resistance levels and sell their short positions at lower positions within the channel. 

Generally traders are recommended to trade with the trend and you can do so in Channel trading.  Instead of selling at the top of the channel in an up trend or bottom of the channel in a down trend, traders may not sell and let profits run.  Traders may decide to close some of their position, taking partial profits.  The market will run against them for a while, but if you are confident of the trend then the market will turn in your favour before being stopped out.  We'll explore these pull-backs or retracement's in later modules.  

Channel Trading Example

EUR/CAD Channel Trading Example

In the above EUR/CAD daily chart we can see the price has been trending down in a channel.  It's been trending for  quite sometime and this is only a snap shot of the channel.  The theory is the same as range trading, although as mentioned above many traders will only trade with the trend.  Lets say a trade is placed at point 1, once channel confirmation has been established.  In this instance we would short the EUR/CAD at about 1.5000, hoping that price will fall within the channel.  For good money management we're going to place a stop/loss order too outside the channel.  Because trend line drawing isn't an exact science sometimes price overshoots the channel, even though it's still following the trend.  We need to let our trades breathe, therefore place stop/loss on the green line.  

Price did fall, but not immediately to the bottom of the channel.  It reversed to point 2, before hitting point 3 at support.  Point 2 is still within the channel and we've not been stopped out. so we could have added to our short order, or just let it be thinking price will go down.  Support was eventually Reached at point 3.  Our decision here is whether to take all profits by closing the order, take some profit, or to let it run thinking that the down trend channel will continue.  Eventually any of our pen trades would have been stopped out at point 6 and we would have had to start again.

The Inefficient Trade

When trading other Indicators like oscillators will be used before entering and exiting trades.  Without peak and trough analysis and trend lines we may have made an inefficient trade.  Even if it's blatantly obvious we're in a down trend it may take quite some time before we're in profit, or worse still we can get stopped out.  If we placed a short sell order at point 7 thinking price will fall, then we'd probably stopped out losing money.  Even if we hadn't stopped out we wouldn't have been in profit for 2.5 days.  This is fine if you have a very long-term view, but if your horizon is a day or week, then trade timing is critical.

Break-outs

Let me put this out there. I believe utilising trend lines and support and resistance with Price Action is of great trading valueModule 5. Candlestick Chart Patterns & Price Action has more on this. A channel, support/resistance or chart pattern breakout strategy, while maybe having less impressive performance statistics during ‘in sample’ back testing, but will probably show a more robust performance over time. 

The reason that channel breakout systems have stood the test of time is likely because markets trend in the long term and a new multi-month high is always going to have much more psychological significance than the crossing of two arbitrary moving averages, or an under sold stochastic.  My findings strongly support the argument that any system based on predictable market behaviour, is likely to be much more robust than one based on arbitrary mathematical algorithms.

Support & Resistance as part of Range Trading

Identifying Support and Resistance is fairly straight forward enough to do on all chart timeframes IMHO. The key is the price reaction at those areas. At it's simplest anytime there's a rally the base of the rally can be called Support on the chart, Buyers supported that area by buying. Vice versa for selling. The more times the support/resistance area is retested the more valid your support/resistance is. Please note that I see Support/Resistance as areas and not one price.

I find the harder part to my trading is to know how to trade that support/resistance. There's always the old chestnut of "Buy at Support and Sell at Resistance" but you never really know if it's support until after you've bought and there's also the chance that support won't be fully tested so you're not in a position to buy. Maybe It should read "Buy at or near Old Support and Sell at or near Old Resistance" but I do believe that it's the best place to buy or sell as it gives me natural areas in which to place stops i.e. under said support if buying.

To help get a feel for market direction I look at the price reaction at those support/resistance areas that I've identified. If I see the market go up 70 points in 2 days from the support area and at resistance only goes down 20 points in 3 days. I'd say that demand was present at support but didn't see supply present itself in such a fashion at resistance. Therefore my outlook for that timeframe would be more bullish than bearish. I would feel more comfortable buying at/near support than selling at/near resistance. I also find that timeframes are very important to my trading as what often appears to be a major support area on a daily chart might be nothing more than a correction on a weekly/yearly chart. The longer term support/resistance areas are most important to my trading. e.g. Support on a 5 minute chart is nowhere near as important as on a yearly chart. If support/resistance areas tie up on more than one timeframe then you have a tradable market IMHO. For each timeframe I decide whether I'm Bullish, Neutral or Bearish and it's often the case that I'm Bullish on the weekly chart and Bearish on the daily chart for the same equity.

I personally find that once the resistance area is broken a very profitable area to enter long is at the retest of that old area, hence the adage "Old resistance becomes new support" and vice versa for Resistance. There's a number of questions that need to be answered when I trade off support/resistance and as with anything the more I trade the better/more confident I get at answering them. I'd also say that my approach is very subjective and I have to make many "Judgement Calls" on what I see around the support/resistance areas. I would love to find a non-subjective system but have yet come across anything which does not require the trader to use his/her judgment when deciding to buy/sell.

I hope this helps, Dan



To Sum Up

The key to profiting is accurately identifying and exploiting these trends in real time, which can be more difficult than it sounds. As a result, it is wise to trade this technique with a practice account - as it is any new technique you are learning - before going live. And, remember to use stop/loss to limit your losses.  As with the above trading example, even though the market price went higher, it took several months to reach the target.  A judgement call needs to be made on whether to continue the trade, or sell it.

Technical analysis is not an exact science and although these indicators and patterns can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

Simple Range Trade System

Chart Set Up: Identify important support and resistance levels on the hourly chart. Most good charting packages do this job for you, but it's possible to do it yourself with screen time.

Add the Stoch (5,3,3) oscillator to your chart to pinpoint possible long and short entries in the market.


Execution 

1. Wait either for a pull back towards support or a rally towards resistance.

2a. For long trades: Go long if price touches support and reverses long with a positive stoch cross from below 20 (see chart above) 

2b. For short trades: Go short if the price touches resistance and reverses with a negative stoch cross from above 80.

3.  A stop loss is set just  below the most recent level of support @ 0.8314. 

4. Target is just below resistance 

As we can see from the chart AUD/USD price touches a significant support level and goes back up. (AUD/USD holds support). The gray circle indicates the time to go long in the market @ 0.8365 (Stoch cross from below 20).

NB. This is a simple set up and system. Extensive testing in your market with an appropriate reward to risk ratio is needed and once again other T.A. should be used to confirm price reversal, i.e candlestick patterns. We go on to talk about these later in the resource



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