ASX Charting Course

Chapter 3

Trend Channel

Construction

Use a normal hi, lo, close bar chart. To construct a trend channel begin with the basic trend line, below the price bars in the case of an up trend and above the price bars in the case of a down trend. A parallel line is then drawn on the other side of the price bars, so that the price action is completely within the channel. In the case of an up trend channel the high side of the channel is drawn across the tops, while in the case of a down trend channel the low side of the channel is drawn across the bottoms.

Use

The trend channel can be used as a target indicator, as well as providing a general sense of direction and a projected range for new price action.

In the case of a trending market, it's sometimes difficult to find support and resistance, especially if the market is at a new high or low. Once price reaches the upside of a trend channel, in the case of a bull market, it's a fair indication of a potential top, an end to that particular move. One could expect the market to move toward the other side of the channel as a result.

If price moves outside the trend channel, there’s a high probability that the market will continue in that direction. We can use the width of the previous trend channel as a target projection point for such a move. The broken trend line can be used as support or resistance in the case of a retracement.

Variations

There are not that many ways you can use trend channels other than for price projection targets and it must be emphasised that even then they are not accurate or reliable. In the example below I've tried to demonstrate how the market will create trend channels within channels and these channels all develop in parallel, but not always. In the first example, fig 3 there is a minor channel within the larger channel, although it's at a steeper gradient.

In the next example, it's much easier to see how minor channels develop. It also demonstrates how you can use these minor channels for price projection. Not only on the down side in the case of a down trend channel, but also for the retracement legs on the upside. As price breaks out from the bottom channel to higher prices, it finds resistance from a lessor channel higher.

Once again it demonstrates the necessity for a policy on reading breaks of price levels, trend lines. Some traders will use any breach as valid, while others require a more conservative assessment and therefore a close on a breach. In which case the chart below leaves price closing above the broad trend channel and therefore issuing a buy signal. That top trend line now becomes support and triggers a sell signal on a break back through that line.