Use a normal high, low, close bar chart. To construct a trend channel begin with the basic trend line, below the price bars in the case of an up trend and above the price bars in the case of a down trend. A parallel line is then drawn on the other side of the price bars, so that the price action is completely within the channel. In the case of an up trend channel the high side of the channel is drawn across the tops, while in the case of a down trend channel the low side of the channel is drawn across the bottoms.
The trend channel can be used as a target indicator, as well as providing a general sense of direction and a projected range for new price action.
In the case of a trending market, it is sometimes difficult to find support and resistance, especially if the market is at a new high or low. Once the price reaches the upside of a trend channel, in the case of a bull market, it is a fair indication of a potential top, an end to that particular move. One could expect the market to move towards the other side of the channel as a result.
If the price moves outside the trend channel, there is a high probability that the market will continue in that direction. We can use the width of the previous trend channel as a target projection point for such a move. The broken trend line can be used as support or resistance in the case of a retracement.
Trend channels are used primarily for price projection targets, but it must be emphasised that there is no guarantee of accuracy or reliability. The example below shows how the market creates trend channels within channels, and these channels often, but not always, develop in parallel. In Figure 1, above, there is a minor channel within the larger channel, but it is at a steeper gradient than the main channel.
In the example below, it is easier to see how minor channels develop. The example also demonstrates how you can use these minor channels for price projection, not only on the down side in the case of a down trend channel, but also for the retracement legs on the upside. As price breaks out from the bottom channel to higher prices, it finds resistance from a lesser channel higher.
Figure 2 once again demonstrates the need for a policy on reading breaks of price levels and trend lines. Some traders regard any breach as valid, while others are more conservative and require a close on a breach. Taking the latter approach, the chart below leaves price closing above the broad trend channel and therefore issues a buy signal. The top trend line now becomes support and triggers a sell signal on a break back through that line.
© The MacLean Group Pty Ltd ACN 096 967 038. All rights reserved 2003. This article has been prepared by The MacLean Group and licensed to ASX. The views are those of the author and not of ASX. This material is educational and it is not intended to constitute financial advice.