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4 WAYS TO TRADE A CHANNEL By Galen Woods in Trading Articles on 25 December 2013 Read more about Channel Trading Do you trade with a channel? There are dozens of channel for trading including linear regression channel, moving average channel, and trend line channel. Regardless of your favorite channel tool, there are 4 ways to trade them. Let’s learn about them to make the most out of your trading channel. TRADING TRENDS WITH CHANNELS This is a trend trading strategy. To use this trading method, you must have a channel that is sloping at a healthy angle to confirm that the market is trending. A trend line channel is the perfect tool for this trading method.
Let’s go through this channel trading example.
1.
We drew a trend line with two swing highs. The trend line was sloping downwards.
2.
Then, we drew a parallel line starting with the swing low to complete the channel.
3.
Prices went up to test the trend line, which is also at the level of a previous congestion area. Hence, the context was excellent for a bear trade, so we went short with the bearish inside bar.
4.
The channel trend line provided the perfect price target for this trend trade.
We could have taken the short trade using only the trend line. However, having the channel gave us a clear exit point for this trade. To learn more about trading trends with trend line channels, read Channel Surfing: Riding the Waves of Channels to Profitable Trading
. TRADING REVERSALS WITH CHANNELS When price exceeds the channel trend line, it could be a climatic move, implying that the trend has exhausted itself. We can then look out for reversal trades like the one below.
Reversal trades are usually low probability trades so we must select only the best trades. Follow these rules to find the best reversal trades.
Ensure that the channel is going against the trend of the higher time-frame. Effectively, you are looking for a retracement of a larger, more powerful trend.
Trade reversals with steep channels. Steep channels are unsustainable.
Strong rejection of break-out of channel trend line. (like the outside bar in the example above)
TRADING RANGES WITH CHANNELS Channels are not just for trending markets. They are also useful in highlighting range-bound trades. In horizontal channels, we can trade without directional bias. We can sell short at the top of the channel and buy at the bottom.
The Gimmee bar trading setup is an example of trading ranges with channels. However, in the Gimmee bar strategy, the Bollinger Bands acted as the channel.
Read our review of the Gimmee bar trading setup to learn more. TRADING BREAK-OUTS WITH CHANNELS The earlier strategies assume that the channel will contain price action and seek to buy low, sell high. What if this assumption fail? Then, we might have a break-out trading setup that often offers quick profits. However, judging which break-outs are valid is an art that is hard to master.
Pay attention to volume. Valid breakouts are strong with increased volume.
Look out for break-out bars with above average bar range. (Read Yum-Yum continuation pattern.)
For trading strategies that finds break-outs with channels, take a look at:
Quick Trade using Linear Regression Channel – A classic example of a break-out trade.
A Simple Day Trading Strategy – It uses MACD to confirm the breakout of Bollinger Bands.
MAKE THE MOST OUT OF TRADING CHANNELS Channels are powerful trading tools that highlight trading opportunities for all 4 types of basic trade setups. However, for some traders, having too much trading options is a drawback. They look for trading setups everywhere. They take a retracement trade, and then a reversal trade, and then think that a breakout is impending. All these within a few minutes. They are overtrading. A solution is to draw a larger channel to analyze the larger price context and only take trades in its direction. For indicator-type channels, you can increase both the look-back period setting and the deviation setting to create a larger channel to contain long-term price action.
CHANNELING: CHARTING A PATH TO SUCCESS By Justin Kuepper AAA | Channel trading is a powerful yet often overlooked form of trading that capitalizes on the tendencies of markets to trend. It combines several forms of technical analysis to provide traders with precise points from which to buy and sell, put stop-loss and take-profit levels and much more! This article will show you how to create and effectively trade these amazing instruments. SEE: Technical Analysis Channel Characteristics In the context of technical analysis, a channel is defined as the area between two parallel trendlines and is often taken as a measure of a trading range. The upper trendline connects price peaks (highs) or closes, and the lower trendline connects lows or closes. An example of a channel is shown below. Breakout points in channels indicate bullish (on upward trends) or bearish (on downward trends) signals.
Channels are useful for short-to medium-term trading - not long-term trading or investing. The technique often works best on stocks with a medium amount of volatility. , the volatility determines your profit per trade. Channeling also tends to work best when the technique is combined with other forms of technical analysis, at which we take a closer look below. Finding an Equity Not all equities can utilize this technique as it requires that the underlying equity has an existing channel in its chart. Generally, a channel consisting of four points is necessary for the channel to be considered "tradeable." There are three ways to locate an equity to which this strategy can be applied: 1. Manually look through charts to locate channel patterns.
2. Utilize software or a service that automatically recognizes channel patterns. 3. Subscribe to a company that provides you with a list of equities to which this technique can be applied. Creating a Channel Channels are relatively easy to create using these four simple steps: 1. Locate a relative high and a relative low in the past from which to begin the channel. 2. Locate another subsequent high and low that follows one of the three following patterns (see table below): a.Ascending channel - higher high and higher low. b.Descending channel - lower low and lower high. c.Horizontal channel - horizontal highs and lows. 3. Draw two trend lines - one connecting the two highs, and one connecting the two lows. Note that these two lines should be near parallel. 4. These two lines form your basic channel after there are at least two points with the upper channel and two with the lower channel. More points enhance the reliability of the channel.
Trading the Channel Channels provide a clear, systematic way to trade. In fact, these simple
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade and how long you should expect the trade to take! Let's look at how these can be done. Locating Buy and Sell Points Channels help locate optimal buying and selling points. Here are the standard channel trading rules:
When the price hits the top of the channel, sell your existing position and/or take a short position.
When the price is in the middle of the channel, hold.
When the price hits the bottom of the channel, add to your existing position, cover your short and/or buy.
Two exceptions to these rules: 1. 1. If the price breaks through the top or bottom of the channel, then the channel play ends until a new channel is established. 2. If the price drifts between the channels for a prolonged period of time, a new narrower channel may be established. There may be times when other forms of technical analysis are needed to enhance the accuracy of the channel plays, and the overall strength of the channel. Using other techniques in conjunction with channeling can also help you avoid the side effects of the two exceptions listed above. A few useful ones to keep in mind are:
Moving average convergence divergence - These can be used to confirm channel movements, especially after a is made.
Stochastics - These are useful to confirm channel movements.
Volume - Analyzing volume ratios can also help you determine the strengths of different channel movements, which determine the overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a is made to confirm the change in direction.
Candlestick patterns - These are useful for spotting channel breakouts.
Determining Stop-Loss and Take-Profit Levels Channels provide built-in money-management capabilities in the form of stop-loss and take-profit points. Here are the standard rules for determining these points:
If you have bought at the bottom of the channel, set a (moving) take-profit point at the top of the channel. Also, set a (moving) stoploss point slightly below the bottom of the channel, allowing room for regular volatility (taking the beta into consideration).
If you have taken a short position at the top of the channel, set a (moving) take-profit point at the bottom of the channel. Also, set a (moving) stop-loss slightly above the top of the channel, allowing room for regular volatility (taking the beta into consideration).
Determining Trade Reliability Channels provide the ability to determine how likely your trade is to be successful. This is done through something known as confirmations. Confirmations represent the number of times the price has rebounded from the top or bottom of the channel - in essence confirming the accuracy of the channel. Here are the important confirmation levels to :
1-2:Weak channel (non-tradeable).
3-4: Adequate channel (tradeable).
5-6: Strong channel (reliable).
6+: Very strong channel (very reliable).
Estimating Trade Length The amount of time a trade takes to reach a sell point from a buy point
can also be calculated using channels. This is done by recording the amount of time it has taken for trades to execute in the past, then averaging the amount of time for the future. This strategy relies on the theory that channel price movements tend to be nearly equal in time and price. Conclusion Channels provide one of the most accurate methods from which to trade in any market. By "encasing" an equities price movement into two parallel trend lines, this simple chart can provide the exact points from which to buy and sell, create stop-loss and take-profit points, check channel strength and even estimate how long the trade will take. This technique is a valuable asset to any trader.
NR7 TRADING STRATEGY By Galen Woods in Trading Setups on 16 January 2014 Read more about Bar Patterns The quiet period before the next explosive market move is like the calm before the storm. NR7 helps us to find the calm so that we can prepare and profit from the impending storm. NR7 means narrow bar 7. It is a bar that has a smaller range than the six bars before it. It is a range contraction that precedes range expansion. In our trading strategy, we add a simple trend rule to find low risk trend trades. TRADING RULES – NR7 TRADING STRATEGY Long Trading Strategy 1.
Past 7 bars are completely above the 20-period EMA
2.
Buy on break of high of NR7 bar
Short Trading Strategy 1.
Past 7 bars are completely below the 20-period EMA
2.
Sell on break of low of NR7 bar
NR7 TRADING EXAMPLES
Winning Trade – Bearish NR7
This is a 3-minute chart of CL futures on NYMEX. The orange line is the 20period EMA. The NR7 bars have a yellow background. 1.
Price swung down from above the EMA with eight consecutive bearish bars.
2.
The seven bars that defined the NR7 bar were all below the EMA, showing that the bearish momentum held up. Although the NR7 bar closed higher than its open, it formed a micro triple top with the two bars before it. After the low of the NR7 bar broke, we went short.
3.
Price came back up to test the break-even level of the trade. However, following a failed bull break-out of the doji NR7, prices plummeted.
The doji NR7 is also a great example to warn us against using NR7 to trade reversals without confirmation from other analysis.
Losing Trade – Bearish NR7
This is another 3-minute chart of CL futures. In this example, the NR7 trade experienced whipsaws. 1.
The seven bars leading up to the NR7 bar were all below the EMA. Despite the four bullish bars in the retracement, price could not reach the EMA.
2.
As price broke the low of the second NR7 bar, we went short. However, the consecutive NR7 bars was a hint of the tight congestion that followed.
3.
Price hit our stop-loss at the high of the NR7 bar. It was a false break-out that reversed and continued the bear trend. Re-entry was a valid option as price stayed below the EMA throughout the retracement and our bearish outlook was not compromised.
REVIEW – NR7 TRADING STRATEGY
Toby Crabel studied the NR7 pattern together with the NR4/ID trading setup. Both patterns are popular trading tools found in many trading strategies. (Read: Day Trading with Short Term Price Patterns and Opening Range Breakout) In this NR7 trading strategy, we looked for markets with a strong trend and used NR7 as a low risk entry point to the trend. Do not follow the trading rules mechanically. Some NR7 bars appear at the high of a bull trend or the low of a bear trend. These setups are not the target of our trading strategy. Wait for a real pullback to enter. Be very careful when you see multiple NR7 bars. Narrow range bars in proximity are a sign of price congestion in which NR7 patterns are less reliable. to follow the path of least resistance. The best NR7 bars occur when price is moving against the path of least resistance.
QUICK TRADE USING LINEAR REGRESSION CHANNEL By Galen Woods in Trading Setups on 17 June 2013 Read more about Channel Trading, Options Trading Quick Trade Using Linear Regression Channel is a trading method from Bernie Schaeffer‘s book, “The Option Advisor: Wealth-Building Techniques Using Equity & Index Options“, which is an excellent introduction to options trading. It uses linear regression channels to identify trends that are poised to accelerate. Read this for more ways to trade using a channel. To get a linear regression channel, draw a best fit line from a swing point to another, and extend the channel lines 2 standard deviations away on each side of the best fit line. Most technical analysis charting software comes with a linear regression channel drawing tool. We used the time exit rule of 7 days as suggested by Bernie Schaeffer. RULES FOR LONG QUICK TRADE 1.
Draw a linear regression channel connecting two significant swing lows
2.
Prices close above the channel for two consecutive days
3.
Buy with limit order upon retest of top channel line
4.
Exit in 7 days
RULES FOR SHORT QUICK TRADE 1.
Draw a linear regression channel connecting two significant swing highs
2.
Prices close below the channel for two consecutive days
3.
Buy with limit order upon retest of bottom channel line
4.
Exit in 7 days
WINNING TRADE – QUICK TRADE
Quick Trade Winning Trade This is the daily chart of IBM. IBM is an optionable stock so calls can be purchased. Using the Quick Trade using linear regression channel, we would have entered the trade as prices fell back to the top channel line as shown by the green arrow. Exiting in 7 days (red arrow) would have given our call options a good return. Let’s take a closer look at this winning trade example. 1.
For the linear regression channel, I chose a major swing low as the starting point, and adjust the ending point of the channel as new swing lows formed. Hence, the linear regression channel changes as price action unfolds, making this strategy a dynamic one.
2.
In the bounce up from the bottom of the channel, we had a breakaway gap, which gave to our long trade.
3.
The two consecutive closes above the channel is an important filter to avoid false breakouts.
LOSING TRADE – QUICK TRADE
Quick Trade Losing Trade In this daily chart, Altera Corp. (ALTR) reversed into an upwards trend. Using the turning point to start our trade using linear regression channel, we got a Quick Trade signal as shown by the green arrow. However, 7 days later, the trade was closed with a loss. The preceding price action gave clear warning signs against taking this Quick Trade.
1.
Prices gapped up but stalled, showing a lack of bullishness.
2.
Prices broke out of the linear regression channel into a resistance zone set by a prior gap. Before this resistance is broken, long trades are a gamble.
3.
Our channel was well-drawn as it contained prices well despite the failed trade. We could have relied on the bounce up from the lower channel line to exit at a better price. However, it is crucial that we respect our time stop of 7 days when trading options, as options value decay with time.
REVIEW – QUICK TRADE USING LINEAR REGRESSION CHANNEL Quick Trade using linear regression channel combines the math behind best fit lines with the trader’s choice of swing points. Well-drawn regression channels have a high probability of success. Always choose a major swing low/high to start the channel so that it contains the main trend. While Quick Trade is an effective trading strategy, opportunities can be limited. Moreover, due to the discretion needed to choose swing points, it is not easy to scan automatically for Quick Trade setups. Be patient and wait for the best trade. Given the leverage in options trading, the wait is worth it. The idea of having a time stop for an options trading strategy is great. Although buying options has limited loss, traders should not hold on to their calls and puts although their edge has already eroded. Quick Trades tend to occur together with the Bollinger Squeeze. It is not surprising as both trading setups are trying to find explosive moves. If you like trading with channels, take a look at Jake Bernstein’s moving average channel day trading strategy.
MOVING AVERAGE CHANNEL DAY TRADE By Galen Woods in Trading Setups on 26 February 2012 Read more about Channel Trading, Day Trading, Moving Average This day trading setup by Jake Bernstein uses a moving average channel to figure out trend and key and resistance levels. For our review, we will build a moving average channel with a 20-period SMA of highs and lows. (Read: Displaced Moving Average Channel Trading Strategy) RULES FOR LONG DAY TRADE 1.
Wait for two consecutive bars to move entirely above the high of the channel
2.
Buy as price tests the 20 SMA of lows (more aggressive traders can buy on test of 20 SMA of highs)
RULES FOR SHORT DAY TRADE 1.
Wait for two consecutive bars to move entirely below the low of the channel
2.
Short as price tests the 20 SMA of highs (more aggressive traders can sell on test of 20 SMA of lows)
WINNING TRADE – MOVING AVERAGE CHANNEL DAY TRADE
Moving Average Channel Day Trade Winning Trade This chart shows a 5-minute chart of ES, the E-mini S&P futures. The two circled bars went completely below the moving average channel and confirmed the down trend.
For a conservative trade, we placed a sell limit order at the top of the channel. As prices spiked up to hit the channel top, we entered a short position at 1347.25. Prices continued down until 1338 and gave a profit potential of 9.25 points, while risking almost nothing as the trade went in our direction immediately after we entered. In this example, the moving average channel highlighted the strong bear spike as price moved beyond the channel. The top channel line gave excellent resistance and minimized our risk. Even if we entered as the bearish outside bar broke the low of the previous bar, it was still a good entry with little adverse movement. LOSING TRADE – MOVING AVERAGE CHANNEL DAY TRADE
Moving Average Channel Day Trade Losing Trade Here, similarly, we had two bars entirely below the channel to confirm the down trend. We then shorted with a limit order at around 1356.75. However, the trade went against us almost immediately and forced out any reasonable stop-loss order.
There were warning signs against taking this trade. First, the two circled bars were not exactly in free fall with the first bar being a doji and the second bar with a long bottom tail. Next, right after channel break-out, there was a classic double bottom followed by four consecutive bullish bars. Following that, you could notice that each bearish bar was followed by either a doji or a bullish bar, suggesting that the bears were giving up the fight. Given this bullish context, we should not take a short trade simply because of the rigid trading rules. REVIEW – MOVING AVERAGE CHANNEL DAY TRADE This trade setup gives the traditional moving average a useful twist. Using the highs and lows to form moving averages is a sound concept as they are the natural and resistance levels of each bar. Hence, it behaves nicely as and resistance. Requiring two bars to go beyond the channel helps to find spikes and avoid ranging conditions. A potential pitfall of using this trading setup is over-reliance on the moving average channel for and resistance. This may cause traders to overlook the real price action unfolding before them.
ANDREW’S PITCHFORK TRADING STRATEGY By Galen Woods in Trading Setups on 27 February 2014 Read more about Channel Trading, Trading Trend Alan Andrew’s Pitchfork is catchy. It catches your attention with its unusual name and its striking pitchfork appearance. It also catches trends with a channel. Essentially, Andrew’s Pitchfork is a tool for drawing price channels. While two lines surrounding price are usually enough to draw a channel, the Pitchfork has an extra line. It is the median line or the handle of the Pitchfork. The median line is central to this trading method. This is why Andrew’s Pitchfork is also known as the Median Line Method. HOW TO DRAW THE ANDREW’S PITCHFORK
There are three steps to drawing a Pitchfork. Step One – Pivot Points You need three points for a Pitchfork. For a bull channel, label:
A major pivot low as point A;
A subsequent higher pivot high as point B; and
The following pivot low as point C.
For a bear channel, label:
A major pivot high as point A;
A subsequent lower pivot low as point B; and
The following pivot high as point C.
Step Two – Median Line Draw a line ing through point A. and the mid-point of point B and C. This is the median line. Step Three – Channel Lines Project parallel lines to both sides of the median line to form the channel. One line should through point B, and the other through point C. The top line is the upper median line and the bottom line is the lower median line. The median line determines the slope of the channel. This is in stark contrast to the normal trend line channel method in which the angle depends on the trend line.
Read: 4 Ways to Trade a Channel In charting packages with an in-built Pitchfork drawing tool, selecting the three pivot points is enough for drawing the Pitchfork. TRADING RULES – ANDREW’S PITCHFORK TRADING STRATEGY There are many ways to trade using Andrew’s Pitchfork but the basic idea is that price will oscillate around the median line. In this version, we will focus on trading the first re-test of the limiting median line. Long Trade 1.
Draw a bull channel with Andrew’s Pitchfork
2.
Wait for price to fall and test the lower median line
3.
No bar high should be lower than the lower median line
4.
Buy a tick above the high of a bull bar at the lower median line
Short Trade 1.
Draw a bear channel with Andrew’s Pitchfork
2.
Wait for price to rise and test the upper median line
3.
No bar low should be higher than the upper median line
4.
Buy a tick below the low of a bear bar at the upper median line
ANDREW’S PITCHFORK TRADING EXAMPLES
Winning Trade – Short SPY Weekly
This SPY weekly chart shows one of the most impressive Pitchfork in the past decade. After all, it caught a huge chunk of the market plunge in 2008/2009. 1.
After making a new low in the downwards trend, the market bounced up to test the upper median line. The resistance was clear as a bearish outside bar formed at the line. This bar was also our signal to go short.
2.
These four points are possible targets for the bear market. In fact, the last target caught the exact bottom of the crisis.
3.
Price rose strongly and broke out of the upper median line. This break-out warned us that the market was not simply having a rest in a down trend. A recovery was underway.
Losing Trade – Short EUR/USD Daily
This EUR/USD daily chart shows another bearish Pitchfork. 1.
Price fell and found resistance at the median line. It bounced up to the upper median line which resisted it. We entered short with the first bearish bar that overlapped with the line.
2.
Although the trade achieved more than 1:1 reward to risk ratio, we consider this trade as a failure because it was a trend continuation trade. Hence, the most conservative target was the last extreme of the down trend. Price rose up above our pattern stop at the high of our signal bar before hitting this conservative target.
3.
After the trend resumed, prices tangled with the median line, showing that this centerpiece was significant.
The timing of this trade was not perfect, but it was not a bad trade. In fact, this chart gives us a great opportunity to introduce sliding parallels.
Sliding parallels are added parallel lines which also act as channel lines. The first sliding parallel provided excellent resistance in this down trend.
This is a textbook example. In ongoing chart analysis, you will have many sliding parallels. (Just keep pushing them to the right by the same distance.) It is not always clear which sliding parallel will be effective. Moreover, if you have too many sliding parallels, you might miss signals of a reversal. REVIEW – ANDREW’S PITCHFORK TRADING STRATEGY Andrew’s Pitchfork is a unique and reliable tool. The median line provides a different market geometry perspective. The trick lies in picking the right pivots.
Pick the major pivots. Ensure that the resulting channel is wide. Wide channels do better and offers a healthier reward to risk ratio. When drawing Pitchforks, there are two common pitfalls. The first is selecting the last pivot (point C) too soon. Exercise patience and let price action confirms the pivot as a major swing point before including it in your Pitchfork. If not, expect more false signals. The second problem is with the person with too many Pitchforks. Some traders are so excited with this new toy that they draw Pitchforks all over the chart. It’s confusing and not helpful. The basic Pitchfork we used is just a part of a massive trading approach that includes sliding parallels, trigger lines, multiple Pitchforks, and variants like Schiff. Most online materials only cover the basic Pitchfork.
CHANNELING: CHARTING A PATH TO SUCCESS By Justin Kuepper AAA | Channel trading is a powerful yet often overlooked form of trading that capitalizes on the tendencies of markets to trend. It combines several forms of technical analysis to provide traders with precise points from which to buy and sell, put stop-loss and take-profit levels and much more! This article will show you how to create and effectively trade these amazing instruments. SEE: Technical Analysis Channel Characteristics In the context of technical analysis, a channel is defined as the area between two parallel trendlines and is often taken as a measure of a trading range. The upper trendline connects price peaks (highs) or closes, and the lower trendline connects lows or closes. An example of a channel is shown below. Breakout points in channels indicate bullish (on upward trends) or bearish (on downward trends) signals.
Channels are useful for short-to medium-term trading - not long-term trading or investing. The technique often works best on stocks with a medium amount of volatility. , the volatility determines your profit per trade. Channeling also tends to work best when the technique is combined with other forms of technical analysis, at which we take a closer look below. Finding an Equity Not all equities can utilize this technique as it requires that the underlying equity has an existing channel in its chart. Generally, a channel consisting of four points is necessary for the channel to be considered "tradeable." There are three ways to locate an equity to which this strategy can be applied: 1. Manually look through charts to locate channel patterns.
2. Utilize software or a service that automatically recognizes channel patterns. 3. Subscribe to a company that provides you with a list of equities to which this technique can be applied. Creating a Channel Channels are relatively easy to create using these four simple steps: 1. Locate a relative high and a relative low in the past from which to begin the channel. 2. Locate another subsequent high and low that follows one of the three following patterns (see table below): a.Ascending channel - higher high and higher low. b.Descending channel - lower low and lower high. c.Horizontal channel - horizontal highs and lows. 3. Draw two trend lines - one connecting the two highs, and one connecting the two lows. Note that these two lines should be near parallel. 4. These two lines form your basic channel after there are at least two points with the upper channel and two with the lower channel. More points enhance the reliability of the channel.
Trading the Channel Channels provide a clear, systematic way to trade. In fact, these simple
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade and how long you should expect the trade to take! Let's look at how these can be done. Locating Buy and Sell Points Channels help locate optimal buying and selling points. Here are the standard channel trading rules:
When the price hits the top of the channel, sell your existing position and/or take a short position.
When the price is in the middle of the channel, hold.
When the price hits the bottom of the channel, add to your existing position, cover your short and/or buy.
Two exceptions to these rules: 1. 1. If the price breaks through the top or bottom of the channel, then the channel play ends until a new channel is established. 2. If the price drifts between the channels for a prolonged period of time, a new narrower channel may be established. There may be times when other forms of technical analysis are needed to enhance the accuracy of the channel plays, and the overall strength of the channel. Using other techniques in conjunction with channeling can also help you avoid the side effects of the two exceptions listed above. A few useful ones to keep in mind are:
Moving average convergence divergence - These can be used to confirm channel movements, especially after a is made.
Stochastics - These are useful to confirm channel movements.
Volume - Analyzing volume ratios can also help you determine the strengths of different channel movements, which determine the overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a is made to confirm the change in direction.
Candlestick patterns - These are useful for spotting channel breakouts.
Determining Stop-Loss and Take-Profit Levels Channels provide built-in money-management capabilities in the form of stop-loss and take-profit points. Here are the standard rules for determining these points:
If you have bought at the bottom of the channel, set a (moving) take-profit point at the top of the channel. Also, set a (moving) stoploss point slightly below the bottom of the channel, allowing room for regular volatility (taking the beta into consideration).
If you have taken a short position at the top of the channel, set a (moving) take-profit point at the bottom of the channel. Also, set a (moving) stop-loss slightly above the top of the channel, allowing room for regular volatility (taking the beta into consideration).
Determining Trade Reliability Channels provide the ability to determine how likely your trade is to be successful. This is done through something known as confirmations. Confirmations represent the number of times the price has rebounded from the top or bottom of the channel - in essence confirming the accuracy of the channel. Here are the important confirmation levels to :
1-2:Weak channel (non-tradeable).
3-4: Adequate channel (tradeable).
5-6: Strong channel (reliable).
6+: Very strong channel (very reliable).
Estimating Trade Length The amount of time a trade takes to reach a sell point from a buy point
can also be calculated using channels. This is done by recording the amount of time it has taken for trades to execute in the past, then averaging the amount of time for the future. This strategy relies on the theory that channel price movements tend to be nearly equal in time and price. Conclusion Channels provide one of the most accurate methods from which to trade in any market. By "encasing" an equities price movement into two parallel trend lines, this simple chart can provide the exact points from which to buy and sell, create stop-loss and take-profit points, check channel strength and even estimate how long the trade will take. This technique is a valuable asset to any trader.
THE 'CHANNEL BOUNCE' TRADING STRATEGY, EXPLAINEDADD TO ... CORY MITCHELL - INVESTOPEDIA Special to The Globe and Mail PublishedThursday, Apr. 10 2014, 4:19 PM EDT Last updatedThursday, Apr. 10 2014, 4:35 PM EDT
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The S&P 500 SPDR is within a broadening wedge formation since the start of March, and bounced off the lows of that formation on April 8. A continued rise in the index toward the highs at $187.70 will favor these stocks bouncing off their own channel lines. These four stocks are all moving within strong trend channels, and currently near channel . The line provides a potential buy area, with the resistance line – top of the channel – providing a target. More Related to this Story
Time to Think About Utility Stocks?
Using the Coppock Curve to Generate Stock Trade Signals
Which Direction Is The Market Heading?
Multimedia Brocade Communications Systems Inc. channel bounce chart
Multimedia Covidien channel bounce chart
Multimedia Qualcomm Inc. channel bounce chart
Multimedia Consol Energy Inc. channel bounce chart The targets provided below are based on the current top of the channel. Over time the channel is rising, so if these trades last weeks or months, the targets will slowly creep up as the upper channel line rises. The current trend channel in Brocade Communications has been in place since December. The stock dipped below $10 briefly on April 7, which was a test of the channel bottom. So far the channel has held, providing a
buying opportunity between $10 and $10.30. A stop can be placed below $9.85, with an upside target near the channel top at $11. Covidien has been moving in a $5 channel (approximately) since October. The stock is currently falling aggressively toward the lower channel line; if that selling strength continues, buying isn’t recommended. Though, if the stock slows its decent between $70 and $69, that is a different story. A pause and then a bounce near the trendline is ideal, providing an entry between $71 and $70 with a stop below $69. Target is the upper portion of the channel, between $74 and $74.75. One thing to be wary of is that the channel is slightly converging, in a wedge pattern. Wedges are often followed by a reversal. A strong break below $68.50 indicates this scenario could be underway. Qualcomm is currently near the middle of its channel, but short-term momentum is down, signalling the price could soon test the channel bottom. If the price slows and reverses between $76.50 and $75.75, buys can be initiated in that area or slightly above. A stop can be placed just below the newly formed bottom (yet to be determined) or at $75.50. Target is the top of the channel, which is currently near $81.75. The trend channel in Consol Energy is less angled than the former stocks mentioned, indicating a bit more hesitancy on the part of the buyers. That said, the stock has been swinging well within the channel. Both the upper and lower channel lines have been penetrated a number of times. That will make the entry and exit points within stock more subjective, as the entry and exit areas will be slightly larger than normal. Currently, the stock is near the middle of the channel, so it may take some time before an entry signal occurs. The entry area is currently between $39.50 and $38.50, but that entry area will rise slowly over time. A stop can be placed below $38.20, or a new low once it develops (yet to be determined). Target area is $42.10 to $42.65.
The bottom line Trend channels provide a visually appealing way to spot trading opportunities. The structure of the pattern highlights the buying area (), the target area (resistance) and stops are placed just outside the pattern. Ideally let the price pause and bounce at the lower trendline. This shows the selling has slowed and buyers are stepping back in. If the price bounces too aggressively off the channel bottom–say to the middle of the channel–leave the trade alone, as the risk is now likely to exceed the diminished reward. The goal is to get in near the channel bottom, and ride the wave to the top.
BETWEEN EXTREMES: TRADING WITH CHANNELS By Bramesh Bhandari March 26, 2013 • Reprints Channels are an important technical condition prevalent on almost all price charts on all time frames. Traders use these simple formations to identify profitable trade setups on both the long and short sides. If drawn and analyzed correctly, price channels can provide precise entry, exit, stop-loss and profit-taking levels for all types of traders in all markets. However, price channels have their limits, and those who put too much faith in them can get burned. A price channel combines an existing trendline with a second, parallel trendline so that when the lines are taken together, they fully contain the price fluctuations in the current leg of the move. The upper trendline connects significant highs of the move, and the lower trendline connects the lows of the move. These trendline levels represent areas where key demand () and supply (resistance) exist. An asset’s price will oscillate between these levels — the upper and lower trendlines — helping traders position their entries and risk-aware exits. All else equal, buy entries tend to be more profitable when placed at the lower end of the channel, and sell entries tend to be more profitable when placed at the upper end. Of course, that thinking assumes the channel will hold. Likewise, traders can set stop-loss and profit-target orders in the vicinity of these established highs and lows to protect the bottom line or get the most out of a position.
“Stepping higher” (above) shows a typical price channel in the S&P 500 stock index. After setting a low of 1266 on June 8, 2012, the S&P 500 generated a series of higher highs and higher lows — the classic definition of an uptrend. Although relatively short in duration, this is a typical example of how price trends play out, with surges and retracements that, when taken together, result in a net move in a predominant direction. What also is clear is that channels aren’t always picture perfect. Highs and lows are fluid, and traders must be alert and flexible as channels develop. Line drawings Price channels are simply lines on a chart. They are easy to draw, but it’s important to approach the process in a systematic manner:
Identify a consecutive swing high and swing low pair. A swing price is simply a high (or low) that is surrounded by a defined number of lower highs (or higher lows) on either side.
If price is rising — it is in an uptrend — draw a line to the right off the swing high, connecting subsequent swing highs. This is the resistance line.
Alternatively, if price is falling — it is in a downtrend — draw a line to the right off the swing low, connecting subsequent swing lows. This is the line.
After you have drawn the resistance or line, draw a second line that connects the opposite extreme of the moves within the trend. Ideally, this line will be parallel to the resistance or line that defines the rate of change for the move. Like trendlines, the vast majority of channels rise or fall, identifying uptrends or downtrends. As you might expect, uptrend channels are considered bullish and downtrend channels are considered bearish. A driving philosophy of channel trading is that the pattern of consistent highs and lows will persist. Per this assumption, buy when price nears the rising line in an uptrend and book profits when price approaches the rising resistance line (see “On the up and up,” below). A common riskmanagement practice in this bullish scenario is to set a stop-loss order slightly below the line. More risk-seeking traders also can trade against the trend — selling when price bounces off the resistance line in an uptrend or buying when prices reacts off the line in a downtrend.
This trading strategy is simply flipped on its head for a downtrend channel. Sell when price nears the falling resistance line in the downtrend and liquidate the trade when price approaches the falling line. The stop loss would be placed just above the resistance point at trade initiation. Risk-seeking traders also can elect to establish a long position at . Channels don’t always rise or fall. They also can contain sideways moving markets (see “Swinging sideways,” below). Although advanced traders often will sell options during such periods to take advantage of the market’s reluctance to establish a defined trend, traditional traders should consider sitting on the sidelines as the opportunities for big moves are muted.
Rules to trade by Although channel analysis helps investors take advantage of price oscillations, always this key rule: When the channel is broken, it’s done. Although there are certainly numerous cases of temporary violations of channel and resistance levels, don’t assume this will happen. Betting against the break and being wrong can be quite costly. The channel can re-establish itself, of course, but make no assumptions. Wait for the swing highs and lows to re-develop and trade off them. However, that doesn’t mean a break (up or down) in the trendline is not a trading opportunity. When the line is broken in an uptrend or the resistance line is broken in a downtrend, it often signifies that the market’s expectation about the stock has changed. This break therefore can be used to generate a new bullish or bearish bias in the stock. Any decisive break in the downtrend line is a clear buy signal. Similarly, any decisive break in the uptrend line is a clear sell signal. In both cases, the main trendline value should be used as the stop loss.
A break in the opposite channel line, on the other hand, indicates that the trend is becoming stronger. Traders might consider taking a fresh long position to participate in the initial euphoria that often follows such a break, or they can wait for a pullback and establish a new long at a more favorable price. In either case, keep in mind that breaks are typically volatile periods, and may be best left to nimble traders with seasoned risk-control techniques. An early signal of a coming break might be given when prices fail to reach a channel line, turning in the middle of the channel’s width. Such returnline failure indicates that the channel is weakening and investors must be cautious with their trades when prices revisit the original trendline. Channels also work well with complementary indicators. Moving averages, which depict the direction and extent of a trend, and oscillators, which can reveal intricacies of how quickly, slowly, strongly or weakly prices are moving within a channel, both are particularly helpful. Channels are useful for short- to medium-term trading. They are not longterm trading tools. They also work particularly well on stocks with a medium amount of volatility. However, even long-term traders should be aware of channel formations. Any violation in this simple price pattern can foretell significant shifts in market sentiment and profit opportunities going forward.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY Linear Regression is an eSignal charting tool using the least-squares fit mathematical method to statistically plot a "best-fit" straight line through the exact middle of the prices over a given period of time. A Linear Regression trendline shows where an equilibrium or mid-point price exists. General Overview of the Linear Regression Tool Linear Regression identifies when prices overextend from a median point. The distance a price migrates above or below a linear regression line indicates the extreme buying or selling perspective from the average point. The slope of the line is called the midpoint or median line. The midpoint or slope of a line is determined by the calculation method. In eSignal, the "close" of a data bar is the default value used for the linear regression calculation. Linear Regression Channels are parallel lines that are a standard deviation away from the linear regression line on either side of it. These lines are also called confidence bands. They act as and resistance lines. Statistically, linear regression channel lines should contain price movement. The percentage of price containment depends on the standard deviation used. Prices may extend outside the channel lines for a brief time. However, if they remain outside the channel, it suggests that, either an existing trend is accelerating or a possible reversal in trend is growing. The space inside the channel is where the equilibrium exists, where price may deviate from the linear regression line yet stay within the existing overall trend.
Setting Standard Deviations Trading effectively using Linear Regression requires setting appropriate standard deviations. Use parallel lines as and resistance confidence bands spaced equally on either side of the regression line. Standard deviation settings vary based on the slope of the existing trend. Experimentation suggests that a standard deviation setting of 1 is too tight for trading in normal conditions, and a setting of between 2 to 3 is effective. A setting of 5 can be used in extreme range scenarios. In addition, the number of bars used in a calculation also determines how well the Linear Regression "fits" the immediate price trend pattern. The more data bars in a calculation, statistically speaking, the better the fit. Aggressive Number of Bar settings used include 60, 70 and 90. The eSignal default set to 0 means all data is used for a Linear Regression calculation. While there are several ways to trade using Linear Regression Channels, this strategy focuses on using the following settings: Source = Open, Number of Bars = 0, Standard Deviation = 2. The eSignal Linear Regression Channel Trading Strategy: The Setup A simple trading strategy is to set the standard deviation to 2, look for a stock trading in a trend and trade the extreme Linear Regression Channel swings. To use this strategy, make the Linear Regression median line your first target. In a best-case scenario, use the opposite linear regression channel line as your second target. Use the outer channel lines and price pivot as an initial stop loss, trail stops appropriate to the position and, as price approaches targets, tighten your trailing stop. NOTE: Use this setup for the Sell Strategy and the Buy Strategy described subsequently.
1. Right click on an eSignal chart to activate the main menu and select "Basic Studies" from the menu.
Study Properties / Explanation 14
1
3
80
%K
%K
%D
Upper band
Length
Smoothing
2. Select "Linear Regression".
3. Adjust the settings in the Linear Regression basic study window as follows: Source = Open, Number of Bars = 0, Standard Deviation = 2.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY: THE BUY STRATEGY 1.
A. Find a trending market that has a major pullback in progress.
B. Buy the extreme price swing at the lower outer linear regression channel.
C. Place an appropriate trailing stop below the lowest price bar spike at the lower channel. (The reward potential for the risk taken should be 1.6 or greater.)
2.
A. Make the linear regression median line your first target. B. Make the lower channel line your second target if the price trades through the median line.
C. Maintain an appropriate trailing stop for your position.
D. Once your initial target is met, tighten your trailing stop.
E. If the price continues through the median line and approaches the lower regression channel line, prepare to close the position out as it exceeds initial expectations.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY: THE SELL STRATEGY 1.
A. Find a trending stock that has not exceeded the upper channel until now.
B. Sell the extreme price swing at the upper outer linear regression channel.
C. Place the appropriate trailing stop above the highest price bar spike at the upper channel. (The reward potential for the risk taken should be 1.6 or greater.)
2.
A. Make the linear regression median line your first target. B. Make the lower channel line your second target if the price trades through the median line.
C. Maintain an appropriate trailing stop for your position.
D. Once your initial target is met, tighten your trailing stop.
E. If the price continues through the median line and approaches the lower regression channel line, prepare to close the position out as it exceeds initial expectations.
Let’s go through this channel trading example.1.
We drew a trend line with two swing highs. The trend line was sloping downwards.
2.
Then, we drew a parallel line starting with the swing low to complete the channel.
3.
Prices went up to test the trend line, which is also at the level of a previous congestion area. Hence, the context was excellent for a bear trade, so we went short with the bearish inside bar.
4.
The channel trend line provided the perfect price target for this trend trade.
We could have taken the short trade using only the trend line. However, having the channel gave us a clear exit point for this trade. To learn more about trading trends with trend line channels, read Channel Surfing: Riding the Waves of Channels to Profitable Trading
. TRADING REVERSALS WITH CHANNELS When price exceeds the channel trend line, it could be a climatic move, implying that the trend has exhausted itself. We can then look out for reversal trades like the one below. Reversal trades are usually low probability trades so we must select only the best trades. Follow these rules to find the best reversal trades. Ensure that the channel is going against the trend of the higher time-frame. Effectively, you are looking for a retracement of a larger, more powerful trend.
Trade reversals with steep channels. Steep channels are unsustainable.
Strong rejection of break-out of channel trend line. (like the outside bar in the example above)
TRADING RANGES WITH CHANNELS Channels are not just for trending markets. They are also useful in highlighting range-bound trades. In horizontal channels, we can trade without directional bias. We can sell short at the top of the channel and buy at the bottom.
The Gimmee bar trading setup is an example of trading ranges with channels. However, in the Gimmee bar strategy, the Bollinger Bands acted as the channel.
Read our review of the Gimmee bar trading setup to learn more. TRADING BREAK-OUTS WITH CHANNELS The earlier strategies assume that the channel will contain price action and seek to buy low, sell high. What if this assumption fail? Then, we might have a break-out trading setup that often offers quick profits. However, judging which break-outs are valid is an art that is hard to master. Pay attention to volume. Valid breakouts are strong with increased volume.
Look out for break-out bars with above average bar range. (Read Yum-Yum continuation pattern.)
For trading strategies that finds break-outs with channels, take a look at:
Quick Trade using Linear Regression Channel – A classic example of a break-out trade.
A Simple Day Trading Strategy – It uses MACD to confirm the breakout of Bollinger Bands.
MAKE THE MOST OUT OF TRADING CHANNELS Channels are powerful trading tools that highlight trading opportunities for all 4 types of basic trade setups. However, for some traders, having too much trading options is a drawback. They look for trading setups everywhere. They take a retracement trade, and then a reversal trade, and then think that a breakout is impending. All these within a few minutes. They are overtrading. A solution is to draw a larger channel to analyze the larger price context and only take trades in its direction. For indicator-type channels, you can increase both the look-back period setting and the deviation setting to create a larger channel to contain long-term price action.
CHANNELING: CHARTING A PATH TO SUCCESS By Justin Kuepper AAA | Channel trading is a powerful yet often overlooked form of trading that capitalizes on the tendencies of markets to trend. It combines several forms of technical analysis to provide traders with precise points from which to buy and sell, put stop-loss and take-profit levels and much more! This article will show you how to create and effectively trade these amazing instruments. SEE: Technical Analysis Channel Characteristics In the context of technical analysis, a channel is defined as the area between two parallel trendlines and is often taken as a measure of a trading range. The upper trendline connects price peaks (highs) or closes, and the lower trendline connects lows or closes. An example of a channel is shown below. Breakout points in channels indicate bullish (on upward trends) or bearish (on downward trends) signals.
Channels are useful for short-to medium-term trading - not long-term trading or investing. The technique often works best on stocks with a medium amount of volatility. , the volatility determines your profit per trade. Channeling also tends to work best when the technique is combined with other forms of technical analysis, at which we take a closer look below. Finding an Equity Not all equities can utilize this technique as it requires that the underlying equity has an existing channel in its chart. Generally, a channel consisting of four points is necessary for the channel to be considered "tradeable." There are three ways to locate an equity to which this strategy can be applied: 1. Manually look through charts to locate channel patterns.
2. Utilize software or a service that automatically recognizes channel patterns. 3. Subscribe to a company that provides you with a list of equities to which this technique can be applied. Creating a Channel Channels are relatively easy to create using these four simple steps: 1. Locate a relative high and a relative low in the past from which to begin the channel. 2. Locate another subsequent high and low that follows one of the three following patterns (see table below): a.Ascending channel - higher high and higher low. b.Descending channel - lower low and lower high. c.Horizontal channel - horizontal highs and lows. 3. Draw two trend lines - one connecting the two highs, and one connecting the two lows. Note that these two lines should be near parallel. 4. These two lines form your basic channel after there are at least two points with the upper channel and two with the lower channel. More points enhance the reliability of the channel.
Trading the Channel Channels provide a clear, systematic way to trade. In fact, these simple
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade and how long you should expect the trade to take! Let's look at how these can be done. Locating Buy and Sell Points Channels help locate optimal buying and selling points. Here are the standard channel trading rules:
When the price hits the top of the channel, sell your existing position and/or take a short position.
When the price is in the middle of the channel, hold.
When the price hits the bottom of the channel, add to your existing position, cover your short and/or buy.
Two exceptions to these rules: 1. 1. If the price breaks through the top or bottom of the channel, then the channel play ends until a new channel is established. 2. If the price drifts between the channels for a prolonged period of time, a new narrower channel may be established. There may be times when other forms of technical analysis are needed to enhance the accuracy of the channel plays, and the overall strength of the channel. Using other techniques in conjunction with channeling can also help you avoid the side effects of the two exceptions listed above. A few useful ones to keep in mind are:
Moving average convergence divergence - These can be used to confirm channel movements, especially after a is made.
Stochastics - These are useful to confirm channel movements.
Volume - Analyzing volume ratios can also help you determine the strengths of different channel movements, which determine the overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a is made to confirm the change in direction.
Candlestick patterns - These are useful for spotting channel breakouts.
Determining Stop-Loss and Take-Profit Levels Channels provide built-in money-management capabilities in the form of stop-loss and take-profit points. Here are the standard rules for determining these points:
If you have bought at the bottom of the channel, set a (moving) take-profit point at the top of the channel. Also, set a (moving) stoploss point slightly below the bottom of the channel, allowing room for regular volatility (taking the beta into consideration).
If you have taken a short position at the top of the channel, set a (moving) take-profit point at the bottom of the channel. Also, set a (moving) stop-loss slightly above the top of the channel, allowing room for regular volatility (taking the beta into consideration).
Determining Trade Reliability Channels provide the ability to determine how likely your trade is to be successful. This is done through something known as confirmations. Confirmations represent the number of times the price has rebounded from the top or bottom of the channel - in essence confirming the accuracy of the channel. Here are the important confirmation levels to :
1-2:Weak channel (non-tradeable).
3-4: Adequate channel (tradeable).
5-6: Strong channel (reliable).
6+: Very strong channel (very reliable).
Estimating Trade Length The amount of time a trade takes to reach a sell point from a buy point
can also be calculated using channels. This is done by recording the amount of time it has taken for trades to execute in the past, then averaging the amount of time for the future. This strategy relies on the theory that channel price movements tend to be nearly equal in time and price. Conclusion Channels provide one of the most accurate methods from which to trade in any market. By "encasing" an equities price movement into two parallel trend lines, this simple chart can provide the exact points from which to buy and sell, create stop-loss and take-profit points, check channel strength and even estimate how long the trade will take. This technique is a valuable asset to any trader.
NR7 TRADING STRATEGY By Galen Woods in Trading Setups on 16 January 2014 Read more about Bar Patterns The quiet period before the next explosive market move is like the calm before the storm. NR7 helps us to find the calm so that we can prepare and profit from the impending storm. NR7 means narrow bar 7. It is a bar that has a smaller range than the six bars before it. It is a range contraction that precedes range expansion. In our trading strategy, we add a simple trend rule to find low risk trend trades. TRADING RULES – NR7 TRADING STRATEGY Long Trading Strategy 1.
Past 7 bars are completely above the 20-period EMA
2.
Buy on break of high of NR7 bar
Short Trading Strategy 1.
Past 7 bars are completely below the 20-period EMA
2.
Sell on break of low of NR7 bar
NR7 TRADING EXAMPLES
Winning Trade – Bearish NR7
This is a 3-minute chart of CL futures on NYMEX. The orange line is the 20period EMA. The NR7 bars have a yellow background. 1.Price swung down from above the EMA with eight consecutive bearish bars.
2.
The seven bars that defined the NR7 bar were all below the EMA, showing that the bearish momentum held up. Although the NR7 bar closed higher than its open, it formed a micro triple top with the two bars before it. After the low of the NR7 bar broke, we went short.
3.
Price came back up to test the break-even level of the trade. However, following a failed bull break-out of the doji NR7, prices plummeted.
The doji NR7 is also a great example to warn us against using NR7 to trade reversals without confirmation from other analysis.
Losing Trade – Bearish NR7
This is another 3-minute chart of CL futures. In this example, the NR7 trade experienced whipsaws. 1.The seven bars leading up to the NR7 bar were all below the EMA. Despite the four bullish bars in the retracement, price could not reach the EMA.
2.
As price broke the low of the second NR7 bar, we went short. However, the consecutive NR7 bars was a hint of the tight congestion that followed.
3.
Price hit our stop-loss at the high of the NR7 bar. It was a false break-out that reversed and continued the bear trend. Re-entry was a valid option as price stayed below the EMA throughout the retracement and our bearish outlook was not compromised.
REVIEW – NR7 TRADING STRATEGY
Toby Crabel studied the NR7 pattern together with the NR4/ID trading setup. Both patterns are popular trading tools found in many trading strategies. (Read: Day Trading with Short Term Price Patterns and Opening Range Breakout) In this NR7 trading strategy, we looked for markets with a strong trend and used NR7 as a low risk entry point to the trend. Do not follow the trading rules mechanically. Some NR7 bars appear at the high of a bull trend or the low of a bear trend. These setups are not the target of our trading strategy. Wait for a real pullback to enter. Be very careful when you see multiple NR7 bars. Narrow range bars in proximity are a sign of price congestion in which NR7 patterns are less reliable. to follow the path of least resistance. The best NR7 bars occur when price is moving against the path of least resistance.
QUICK TRADE USING LINEAR REGRESSION CHANNEL By Galen Woods in Trading Setups on 17 June 2013 Read more about Channel Trading, Options Trading Quick Trade Using Linear Regression Channel is a trading method from Bernie Schaeffer‘s book, “The Option Advisor: Wealth-Building Techniques Using Equity & Index Options“, which is an excellent introduction to options trading. It uses linear regression channels to identify trends that are poised to accelerate. Read this for more ways to trade using a channel. To get a linear regression channel, draw a best fit line from a swing point to another, and extend the channel lines 2 standard deviations away on each side of the best fit line. Most technical analysis charting software comes with a linear regression channel drawing tool. We used the time exit rule of 7 days as suggested by Bernie Schaeffer. RULES FOR LONG QUICK TRADE 1.
Draw a linear regression channel connecting two significant swing lows
2.
Prices close above the channel for two consecutive days
3.
Buy with limit order upon retest of top channel line
4.
Exit in 7 days
RULES FOR SHORT QUICK TRADE 1.
Draw a linear regression channel connecting two significant swing highs
2.
Prices close below the channel for two consecutive days
3.
Buy with limit order upon retest of bottom channel line
4.
Exit in 7 days
WINNING TRADE – QUICK TRADE
Quick Trade Winning Trade This is the daily chart of IBM. IBM is an optionable stock so calls can be purchased. Using the Quick Trade using linear regression channel, we would have entered the trade as prices fell back to the top channel line as shown by the green arrow. Exiting in 7 days (red arrow) would have given our call options a good return. Let’s take a closer look at this winning trade example. 1.For the linear regression channel, I chose a major swing low as the starting point, and adjust the ending point of the channel as new swing lows formed. Hence, the linear regression channel changes as price action unfolds, making this strategy a dynamic one.
2.
In the bounce up from the bottom of the channel, we had a breakaway gap, which gave to our long trade.
3.
The two consecutive closes above the channel is an important filter to avoid false breakouts.
LOSING TRADE – QUICK TRADE
Quick Trade Losing Trade In this daily chart, Altera Corp. (ALTR) reversed into an upwards trend. Using the turning point to start our trade using linear regression channel, we got a Quick Trade signal as shown by the green arrow. However, 7 days later, the trade was closed with a loss. The preceding price action gave clear warning signs against taking this Quick Trade.1.
Prices gapped up but stalled, showing a lack of bullishness.
2.
Prices broke out of the linear regression channel into a resistance zone set by a prior gap. Before this resistance is broken, long trades are a gamble.
3.
Our channel was well-drawn as it contained prices well despite the failed trade. We could have relied on the bounce up from the lower channel line to exit at a better price. However, it is crucial that we respect our time stop of 7 days when trading options, as options value decay with time.
REVIEW – QUICK TRADE USING LINEAR REGRESSION CHANNEL Quick Trade using linear regression channel combines the math behind best fit lines with the trader’s choice of swing points. Well-drawn regression channels have a high probability of success. Always choose a major swing low/high to start the channel so that it contains the main trend. While Quick Trade is an effective trading strategy, opportunities can be limited. Moreover, due to the discretion needed to choose swing points, it is not easy to scan automatically for Quick Trade setups. Be patient and wait for the best trade. Given the leverage in options trading, the wait is worth it. The idea of having a time stop for an options trading strategy is great. Although buying options has limited loss, traders should not hold on to their calls and puts although their edge has already eroded. Quick Trades tend to occur together with the Bollinger Squeeze. It is not surprising as both trading setups are trying to find explosive moves. If you like trading with channels, take a look at Jake Bernstein’s moving average channel day trading strategy.
MOVING AVERAGE CHANNEL DAY TRADE By Galen Woods in Trading Setups on 26 February 2012 Read more about Channel Trading, Day Trading, Moving Average This day trading setup by Jake Bernstein uses a moving average channel to figure out trend and key and resistance levels. For our review, we will build a moving average channel with a 20-period SMA of highs and lows. (Read: Displaced Moving Average Channel Trading Strategy) RULES FOR LONG DAY TRADE 1.
Wait for two consecutive bars to move entirely above the high of the channel
2.
Buy as price tests the 20 SMA of lows (more aggressive traders can buy on test of 20 SMA of highs)
RULES FOR SHORT DAY TRADE 1.
Wait for two consecutive bars to move entirely below the low of the channel
2.
Short as price tests the 20 SMA of highs (more aggressive traders can sell on test of 20 SMA of lows)
WINNING TRADE – MOVING AVERAGE CHANNEL DAY TRADE
Moving Average Channel Day Trade Winning Trade This chart shows a 5-minute chart of ES, the E-mini S&P futures. The two circled bars went completely below the moving average channel and confirmed the down trend.For a conservative trade, we placed a sell limit order at the top of the channel. As prices spiked up to hit the channel top, we entered a short position at 1347.25. Prices continued down until 1338 and gave a profit potential of 9.25 points, while risking almost nothing as the trade went in our direction immediately after we entered. In this example, the moving average channel highlighted the strong bear spike as price moved beyond the channel. The top channel line gave excellent resistance and minimized our risk. Even if we entered as the bearish outside bar broke the low of the previous bar, it was still a good entry with little adverse movement. LOSING TRADE – MOVING AVERAGE CHANNEL DAY TRADE
Moving Average Channel Day Trade Losing Trade Here, similarly, we had two bars entirely below the channel to confirm the down trend. We then shorted with a limit order at around 1356.75. However, the trade went against us almost immediately and forced out any reasonable stop-loss order.There were warning signs against taking this trade. First, the two circled bars were not exactly in free fall with the first bar being a doji and the second bar with a long bottom tail. Next, right after channel break-out, there was a classic double bottom followed by four consecutive bullish bars. Following that, you could notice that each bearish bar was followed by either a doji or a bullish bar, suggesting that the bears were giving up the fight. Given this bullish context, we should not take a short trade simply because of the rigid trading rules. REVIEW – MOVING AVERAGE CHANNEL DAY TRADE This trade setup gives the traditional moving average a useful twist. Using the highs and lows to form moving averages is a sound concept as they are the natural and resistance levels of each bar. Hence, it behaves nicely as and resistance. Requiring two bars to go beyond the channel helps to find spikes and avoid ranging conditions. A potential pitfall of using this trading setup is over-reliance on the moving average channel for and resistance. This may cause traders to overlook the real price action unfolding before them.
ANDREW’S PITCHFORK TRADING STRATEGY By Galen Woods in Trading Setups on 27 February 2014 Read more about Channel Trading, Trading Trend Alan Andrew’s Pitchfork is catchy. It catches your attention with its unusual name and its striking pitchfork appearance. It also catches trends with a channel. Essentially, Andrew’s Pitchfork is a tool for drawing price channels. While two lines surrounding price are usually enough to draw a channel, the Pitchfork has an extra line. It is the median line or the handle of the Pitchfork. The median line is central to this trading method. This is why Andrew’s Pitchfork is also known as the Median Line Method. HOW TO DRAW THE ANDREW’S PITCHFORK
There are three steps to drawing a Pitchfork. Step One – Pivot Points You need three points for a Pitchfork. For a bull channel, label: A major pivot low as point A;
A subsequent higher pivot high as point B; and
The following pivot low as point C.
For a bear channel, label:
A major pivot high as point A;
A subsequent lower pivot low as point B; and
The following pivot high as point C.
Step Two – Median Line Draw a line ing through point A. and the mid-point of point B and C. This is the median line. Step Three – Channel Lines Project parallel lines to both sides of the median line to form the channel. One line should through point B, and the other through point C. The top line is the upper median line and the bottom line is the lower median line. The median line determines the slope of the channel. This is in stark contrast to the normal trend line channel method in which the angle depends on the trend line.
Read: 4 Ways to Trade a Channel In charting packages with an in-built Pitchfork drawing tool, selecting the three pivot points is enough for drawing the Pitchfork. TRADING RULES – ANDREW’S PITCHFORK TRADING STRATEGY There are many ways to trade using Andrew’s Pitchfork but the basic idea is that price will oscillate around the median line. In this version, we will focus on trading the first re-test of the limiting median line. Long Trade 1.
Draw a bull channel with Andrew’s Pitchfork
2.
Wait for price to fall and test the lower median line
3.
No bar high should be lower than the lower median line
4.
Buy a tick above the high of a bull bar at the lower median line
Short Trade 1.
Draw a bear channel with Andrew’s Pitchfork
2.
Wait for price to rise and test the upper median line
3.
No bar low should be higher than the upper median line
4.
Buy a tick below the low of a bear bar at the upper median line
ANDREW’S PITCHFORK TRADING EXAMPLES
Winning Trade – Short SPY Weekly
This SPY weekly chart shows one of the most impressive Pitchfork in the past decade. After all, it caught a huge chunk of the market plunge in 2008/2009. 1.After making a new low in the downwards trend, the market bounced up to test the upper median line. The resistance was clear as a bearish outside bar formed at the line. This bar was also our signal to go short.
2.
These four points are possible targets for the bear market. In fact, the last target caught the exact bottom of the crisis.
3.
Price rose strongly and broke out of the upper median line. This break-out warned us that the market was not simply having a rest in a down trend. A recovery was underway.
Losing Trade – Short EUR/USD Daily
This EUR/USD daily chart shows another bearish Pitchfork. 1.Price fell and found resistance at the median line. It bounced up to the upper median line which resisted it. We entered short with the first bearish bar that overlapped with the line.
2.
Although the trade achieved more than 1:1 reward to risk ratio, we consider this trade as a failure because it was a trend continuation trade. Hence, the most conservative target was the last extreme of the down trend. Price rose up above our pattern stop at the high of our signal bar before hitting this conservative target.
3.
After the trend resumed, prices tangled with the median line, showing that this centerpiece was significant.
The timing of this trade was not perfect, but it was not a bad trade. In fact, this chart gives us a great opportunity to introduce sliding parallels.
Sliding parallels are added parallel lines which also act as channel lines. The first sliding parallel provided excellent resistance in this down trend.
This is a textbook example. In ongoing chart analysis, you will have many sliding parallels. (Just keep pushing them to the right by the same distance.) It is not always clear which sliding parallel will be effective. Moreover, if you have too many sliding parallels, you might miss signals of a reversal. REVIEW – ANDREW’S PITCHFORK TRADING STRATEGY Andrew’s Pitchfork is a unique and reliable tool. The median line provides a different market geometry perspective. The trick lies in picking the right pivots.Pick the major pivots. Ensure that the resulting channel is wide. Wide channels do better and offers a healthier reward to risk ratio. When drawing Pitchforks, there are two common pitfalls. The first is selecting the last pivot (point C) too soon. Exercise patience and let price action confirms the pivot as a major swing point before including it in your Pitchfork. If not, expect more false signals. The second problem is with the person with too many Pitchforks. Some traders are so excited with this new toy that they draw Pitchforks all over the chart. It’s confusing and not helpful. The basic Pitchfork we used is just a part of a massive trading approach that includes sliding parallels, trigger lines, multiple Pitchforks, and variants like Schiff. Most online materials only cover the basic Pitchfork.
CHANNELING: CHARTING A PATH TO SUCCESS By Justin Kuepper AAA | Channel trading is a powerful yet often overlooked form of trading that capitalizes on the tendencies of markets to trend. It combines several forms of technical analysis to provide traders with precise points from which to buy and sell, put stop-loss and take-profit levels and much more! This article will show you how to create and effectively trade these amazing instruments. SEE: Technical Analysis Channel Characteristics In the context of technical analysis, a channel is defined as the area between two parallel trendlines and is often taken as a measure of a trading range. The upper trendline connects price peaks (highs) or closes, and the lower trendline connects lows or closes. An example of a channel is shown below. Breakout points in channels indicate bullish (on upward trends) or bearish (on downward trends) signals.
Channels are useful for short-to medium-term trading - not long-term trading or investing. The technique often works best on stocks with a medium amount of volatility. , the volatility determines your profit per trade. Channeling also tends to work best when the technique is combined with other forms of technical analysis, at which we take a closer look below. Finding an Equity Not all equities can utilize this technique as it requires that the underlying equity has an existing channel in its chart. Generally, a channel consisting of four points is necessary for the channel to be considered "tradeable." There are three ways to locate an equity to which this strategy can be applied: 1. Manually look through charts to locate channel patterns.
2. Utilize software or a service that automatically recognizes channel patterns. 3. Subscribe to a company that provides you with a list of equities to which this technique can be applied. Creating a Channel Channels are relatively easy to create using these four simple steps: 1. Locate a relative high and a relative low in the past from which to begin the channel. 2. Locate another subsequent high and low that follows one of the three following patterns (see table below): a.Ascending channel - higher high and higher low. b.Descending channel - lower low and lower high. c.Horizontal channel - horizontal highs and lows. 3. Draw two trend lines - one connecting the two highs, and one connecting the two lows. Note that these two lines should be near parallel. 4. These two lines form your basic channel after there are at least two points with the upper channel and two with the lower channel. More points enhance the reliability of the channel.
Trading the Channel Channels provide a clear, systematic way to trade. In fact, these simple
instruments can show you when to buy and sell, where to place your stoploss and take-profit points, how to determine the reliability of the trade and how long you should expect the trade to take! Let's look at how these can be done. Locating Buy and Sell Points Channels help locate optimal buying and selling points. Here are the standard channel trading rules:
When the price hits the top of the channel, sell your existing position and/or take a short position.
When the price is in the middle of the channel, hold.
When the price hits the bottom of the channel, add to your existing position, cover your short and/or buy.
Two exceptions to these rules: 1. 1. If the price breaks through the top or bottom of the channel, then the channel play ends until a new channel is established. 2. If the price drifts between the channels for a prolonged period of time, a new narrower channel may be established. There may be times when other forms of technical analysis are needed to enhance the accuracy of the channel plays, and the overall strength of the channel. Using other techniques in conjunction with channeling can also help you avoid the side effects of the two exceptions listed above. A few useful ones to keep in mind are:
Moving average convergence divergence - These can be used to confirm channel movements, especially after a is made.
Stochastics - These are useful to confirm channel movements.
Volume - Analyzing volume ratios can also help you determine the strengths of different channel movements, which determine the overall channel strength.
Short-term moving averages - These can provide you with a shortterm outlook on a channel play. They are most useful after a is made to confirm the change in direction.
Candlestick patterns - These are useful for spotting channel breakouts.
Determining Stop-Loss and Take-Profit Levels Channels provide built-in money-management capabilities in the form of stop-loss and take-profit points. Here are the standard rules for determining these points:
If you have bought at the bottom of the channel, set a (moving) take-profit point at the top of the channel. Also, set a (moving) stoploss point slightly below the bottom of the channel, allowing room for regular volatility (taking the beta into consideration).
If you have taken a short position at the top of the channel, set a (moving) take-profit point at the bottom of the channel. Also, set a (moving) stop-loss slightly above the top of the channel, allowing room for regular volatility (taking the beta into consideration).
Determining Trade Reliability Channels provide the ability to determine how likely your trade is to be successful. This is done through something known as confirmations. Confirmations represent the number of times the price has rebounded from the top or bottom of the channel - in essence confirming the accuracy of the channel. Here are the important confirmation levels to :
1-2:Weak channel (non-tradeable).
3-4: Adequate channel (tradeable).
5-6: Strong channel (reliable).
6+: Very strong channel (very reliable).
Estimating Trade Length The amount of time a trade takes to reach a sell point from a buy point
can also be calculated using channels. This is done by recording the amount of time it has taken for trades to execute in the past, then averaging the amount of time for the future. This strategy relies on the theory that channel price movements tend to be nearly equal in time and price. Conclusion Channels provide one of the most accurate methods from which to trade in any market. By "encasing" an equities price movement into two parallel trend lines, this simple chart can provide the exact points from which to buy and sell, create stop-loss and take-profit points, check channel strength and even estimate how long the trade will take. This technique is a valuable asset to any trader.
THE 'CHANNEL BOUNCE' TRADING STRATEGY, EXPLAINEDADD TO ... CORY MITCHELL - INVESTOPEDIA Special to The Globe and Mail PublishedThursday, Apr. 10 2014, 4:19 PM EDT Last updatedThursday, Apr. 10 2014, 4:35 PM EDT
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The S&P 500 SPDR is within a broadening wedge formation since the start of March, and bounced off the lows of that formation on April 8. A continued rise in the index toward the highs at $187.70 will favor these stocks bouncing off their own channel lines. These four stocks are all moving within strong trend channels, and currently near channel . The line provides a potential buy area, with the resistance line – top of the channel – providing a target. More Related to this Story
Time to Think About Utility Stocks?
Using the Coppock Curve to Generate Stock Trade Signals
Which Direction Is The Market Heading?
Multimedia Brocade Communications Systems Inc. channel bounce chart
Multimedia Covidien channel bounce chart
Multimedia Qualcomm Inc. channel bounce chart
Multimedia Consol Energy Inc. channel bounce chart The targets provided below are based on the current top of the channel. Over time the channel is rising, so if these trades last weeks or months, the targets will slowly creep up as the upper channel line rises. The current trend channel in Brocade Communications has been in place since December. The stock dipped below $10 briefly on April 7, which was a test of the channel bottom. So far the channel has held, providing a
buying opportunity between $10 and $10.30. A stop can be placed below $9.85, with an upside target near the channel top at $11. Covidien has been moving in a $5 channel (approximately) since October. The stock is currently falling aggressively toward the lower channel line; if that selling strength continues, buying isn’t recommended. Though, if the stock slows its decent between $70 and $69, that is a different story. A pause and then a bounce near the trendline is ideal, providing an entry between $71 and $70 with a stop below $69. Target is the upper portion of the channel, between $74 and $74.75. One thing to be wary of is that the channel is slightly converging, in a wedge pattern. Wedges are often followed by a reversal. A strong break below $68.50 indicates this scenario could be underway. Qualcomm is currently near the middle of its channel, but short-term momentum is down, signalling the price could soon test the channel bottom. If the price slows and reverses between $76.50 and $75.75, buys can be initiated in that area or slightly above. A stop can be placed just below the newly formed bottom (yet to be determined) or at $75.50. Target is the top of the channel, which is currently near $81.75. The trend channel in Consol Energy is less angled than the former stocks mentioned, indicating a bit more hesitancy on the part of the buyers. That said, the stock has been swinging well within the channel. Both the upper and lower channel lines have been penetrated a number of times. That will make the entry and exit points within stock more subjective, as the entry and exit areas will be slightly larger than normal. Currently, the stock is near the middle of the channel, so it may take some time before an entry signal occurs. The entry area is currently between $39.50 and $38.50, but that entry area will rise slowly over time. A stop can be placed below $38.20, or a new low once it develops (yet to be determined). Target area is $42.10 to $42.65.
The bottom line Trend channels provide a visually appealing way to spot trading opportunities. The structure of the pattern highlights the buying area (), the target area (resistance) and stops are placed just outside the pattern. Ideally let the price pause and bounce at the lower trendline. This shows the selling has slowed and buyers are stepping back in. If the price bounces too aggressively off the channel bottom–say to the middle of the channel–leave the trade alone, as the risk is now likely to exceed the diminished reward. The goal is to get in near the channel bottom, and ride the wave to the top.
BETWEEN EXTREMES: TRADING WITH CHANNELS By Bramesh Bhandari March 26, 2013 • Reprints Channels are an important technical condition prevalent on almost all price charts on all time frames. Traders use these simple formations to identify profitable trade setups on both the long and short sides. If drawn and analyzed correctly, price channels can provide precise entry, exit, stop-loss and profit-taking levels for all types of traders in all markets. However, price channels have their limits, and those who put too much faith in them can get burned. A price channel combines an existing trendline with a second, parallel trendline so that when the lines are taken together, they fully contain the price fluctuations in the current leg of the move. The upper trendline connects significant highs of the move, and the lower trendline connects the lows of the move. These trendline levels represent areas where key demand () and supply (resistance) exist. An asset’s price will oscillate between these levels — the upper and lower trendlines — helping traders position their entries and risk-aware exits. All else equal, buy entries tend to be more profitable when placed at the lower end of the channel, and sell entries tend to be more profitable when placed at the upper end. Of course, that thinking assumes the channel will hold. Likewise, traders can set stop-loss and profit-target orders in the vicinity of these established highs and lows to protect the bottom line or get the most out of a position.
“Stepping higher” (above) shows a typical price channel in the S&P 500 stock index. After setting a low of 1266 on June 8, 2012, the S&P 500 generated a series of higher highs and higher lows — the classic definition of an uptrend. Although relatively short in duration, this is a typical example of how price trends play out, with surges and retracements that, when taken together, result in a net move in a predominant direction. What also is clear is that channels aren’t always picture perfect. Highs and lows are fluid, and traders must be alert and flexible as channels develop. Line drawings Price channels are simply lines on a chart. They are easy to draw, but it’s important to approach the process in a systematic manner:
Identify a consecutive swing high and swing low pair. A swing price is simply a high (or low) that is surrounded by a defined number of lower highs (or higher lows) on either side.
If price is rising — it is in an uptrend — draw a line to the right off the swing high, connecting subsequent swing highs. This is the resistance line.
Alternatively, if price is falling — it is in a downtrend — draw a line to the right off the swing low, connecting subsequent swing lows. This is the line.
After you have drawn the resistance or line, draw a second line that connects the opposite extreme of the moves within the trend. Ideally, this line will be parallel to the resistance or line that defines the rate of change for the move. Like trendlines, the vast majority of channels rise or fall, identifying uptrends or downtrends. As you might expect, uptrend channels are considered bullish and downtrend channels are considered bearish. A driving philosophy of channel trading is that the pattern of consistent highs and lows will persist. Per this assumption, buy when price nears the rising line in an uptrend and book profits when price approaches the rising resistance line (see “On the up and up,” below). A common riskmanagement practice in this bullish scenario is to set a stop-loss order slightly below the line. More risk-seeking traders also can trade against the trend — selling when price bounces off the resistance line in an uptrend or buying when prices reacts off the line in a downtrend.
This trading strategy is simply flipped on its head for a downtrend channel. Sell when price nears the falling resistance line in the downtrend and liquidate the trade when price approaches the falling line. The stop loss would be placed just above the resistance point at trade initiation. Risk-seeking traders also can elect to establish a long position at . Channels don’t always rise or fall. They also can contain sideways moving markets (see “Swinging sideways,” below). Although advanced traders often will sell options during such periods to take advantage of the market’s reluctance to establish a defined trend, traditional traders should consider sitting on the sidelines as the opportunities for big moves are muted.
Rules to trade by Although channel analysis helps investors take advantage of price oscillations, always this key rule: When the channel is broken, it’s done. Although there are certainly numerous cases of temporary violations of channel and resistance levels, don’t assume this will happen. Betting against the break and being wrong can be quite costly. The channel can re-establish itself, of course, but make no assumptions. Wait for the swing highs and lows to re-develop and trade off them. However, that doesn’t mean a break (up or down) in the trendline is not a trading opportunity. When the line is broken in an uptrend or the resistance line is broken in a downtrend, it often signifies that the market’s expectation about the stock has changed. This break therefore can be used to generate a new bullish or bearish bias in the stock. Any decisive break in the downtrend line is a clear buy signal. Similarly, any decisive break in the uptrend line is a clear sell signal. In both cases, the main trendline value should be used as the stop loss.
A break in the opposite channel line, on the other hand, indicates that the trend is becoming stronger. Traders might consider taking a fresh long position to participate in the initial euphoria that often follows such a break, or they can wait for a pullback and establish a new long at a more favorable price. In either case, keep in mind that breaks are typically volatile periods, and may be best left to nimble traders with seasoned risk-control techniques. An early signal of a coming break might be given when prices fail to reach a channel line, turning in the middle of the channel’s width. Such returnline failure indicates that the channel is weakening and investors must be cautious with their trades when prices revisit the original trendline. Channels also work well with complementary indicators. Moving averages, which depict the direction and extent of a trend, and oscillators, which can reveal intricacies of how quickly, slowly, strongly or weakly prices are moving within a channel, both are particularly helpful. Channels are useful for short- to medium-term trading. They are not longterm trading tools. They also work particularly well on stocks with a medium amount of volatility. However, even long-term traders should be aware of channel formations. Any violation in this simple price pattern can foretell significant shifts in market sentiment and profit opportunities going forward.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY Linear Regression is an eSignal charting tool using the least-squares fit mathematical method to statistically plot a "best-fit" straight line through the exact middle of the prices over a given period of time. A Linear Regression trendline shows where an equilibrium or mid-point price exists. General Overview of the Linear Regression Tool Linear Regression identifies when prices overextend from a median point. The distance a price migrates above or below a linear regression line indicates the extreme buying or selling perspective from the average point. The slope of the line is called the midpoint or median line. The midpoint or slope of a line is determined by the calculation method. In eSignal, the "close" of a data bar is the default value used for the linear regression calculation. Linear Regression Channels are parallel lines that are a standard deviation away from the linear regression line on either side of it. These lines are also called confidence bands. They act as and resistance lines. Statistically, linear regression channel lines should contain price movement. The percentage of price containment depends on the standard deviation used. Prices may extend outside the channel lines for a brief time. However, if they remain outside the channel, it suggests that, either an existing trend is accelerating or a possible reversal in trend is growing. The space inside the channel is where the equilibrium exists, where price may deviate from the linear regression line yet stay within the existing overall trend.
Setting Standard Deviations Trading effectively using Linear Regression requires setting appropriate standard deviations. Use parallel lines as and resistance confidence bands spaced equally on either side of the regression line. Standard deviation settings vary based on the slope of the existing trend. Experimentation suggests that a standard deviation setting of 1 is too tight for trading in normal conditions, and a setting of between 2 to 3 is effective. A setting of 5 can be used in extreme range scenarios. In addition, the number of bars used in a calculation also determines how well the Linear Regression "fits" the immediate price trend pattern. The more data bars in a calculation, statistically speaking, the better the fit. Aggressive Number of Bar settings used include 60, 70 and 90. The eSignal default set to 0 means all data is used for a Linear Regression calculation. While there are several ways to trade using Linear Regression Channels, this strategy focuses on using the following settings: Source = Open, Number of Bars = 0, Standard Deviation = 2. The eSignal Linear Regression Channel Trading Strategy: The Setup A simple trading strategy is to set the standard deviation to 2, look for a stock trading in a trend and trade the extreme Linear Regression Channel swings. To use this strategy, make the Linear Regression median line your first target. In a best-case scenario, use the opposite linear regression channel line as your second target. Use the outer channel lines and price pivot as an initial stop loss, trail stops appropriate to the position and, as price approaches targets, tighten your trailing stop. NOTE: Use this setup for the Sell Strategy and the Buy Strategy described subsequently.
1. Right click on an eSignal chart to activate the main menu and select "Basic Studies" from the menu.
Study Properties / Explanation 14
1
3
80
%K
%K
%D
Upper band
Length
Smoothing
2. Select "Linear Regression".
3. Adjust the settings in the Linear Regression basic study window as follows: Source = Open, Number of Bars = 0, Standard Deviation = 2.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY: THE BUY STRATEGY 1.
A. Find a trending market that has a major pullback in progress.
B. Buy the extreme price swing at the lower outer linear regression channel.
C. Place an appropriate trailing stop below the lowest price bar spike at the lower channel. (The reward potential for the risk taken should be 1.6 or greater.)
2.
A. Make the linear regression median line your first target. B. Make the lower channel line your second target if the price trades through the median line.
C. Maintain an appropriate trailing stop for your position.
D. Once your initial target is met, tighten your trailing stop.
E. If the price continues through the median line and approaches the lower regression channel line, prepare to close the position out as it exceeds initial expectations.
ESIGNAL LINEAR REGRESSION CHANNEL TRADING STRATEGY: THE SELL STRATEGY 1.
A. Find a trending stock that has not exceeded the upper channel until now.
B. Sell the extreme price swing at the upper outer linear regression channel.
C. Place the appropriate trailing stop above the highest price bar spike at the upper channel. (The reward potential for the risk taken should be 1.6 or greater.)
2.
A. Make the linear regression median line your first target. B. Make the lower channel line your second target if the price trades through the median line.
C. Maintain an appropriate trailing stop for your position.
D. Once your initial target is met, tighten your trailing stop.
E. If the price continues through the median line and approaches the lower regression channel line, prepare to close the position out as it exceeds initial expectations.
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