Our series on TREND LINES in the Forex market continues with part 4! Today we focus on how trend lines and trend channels interact and why using the two concepts in tandem is such a powerful trading strategy.
If you would like review our explanation on the psychology behind steep trend lines, how to use steep trend lines for breaks and bounces, and other interesting important elements connected to trend lines, check out part 3 here: If you are interested in reviewing part 1 OR part 2 of the “Number 1 Handbook on Trend Lines” again, you can do so by clicking here (1) and here (2).
TREND LINES AND TREND CHANNELS
Trend lines (TL) and trend channels (TC) share many characteristics among each other such as:
- The relevance of a TL and TC increase when they are closer to price;
- The preference for a TL and TC to have 3 hits or more;
- The fact that a TL and TC should have (some) neatness;
- A distance between the tops and bottoms hitting the TL and TC;
- The fact that a broken TL and TC will have the opposite S&R effect after a break (resistance becomes support; support becomes resistance).
DIFFERENCE BETWEEN LINES AND CHANNELS
There are also important differences. First of all, a trend channel always has 2 lines: one connecting tops and one connecting bottoms, which forms the channel and are at parallel angles. A trend line however only consists of one trend line, and is also called a single trend line (SLT).
Secondly, a trend line can have any angle as long as it meets most of the elements described above (5 points) but a trend channel must have a particular angle (more info later). A trend line can be:
- Flat = horizontal support or resistance level with 0 degree angle;
- Up angle = bullish trend line;
- Down angle = bearish trend line;
- Various angles such as a flag (0-10 degrees), corrective (10-25 degrees), channel (25-45 degrees), steep (45+ degrees).
A trend channel does not have this luxury: it only qualifies as a trend channel if it has a decent angle of 25-45 degrees. The simple reason is that a trend channel must have a trend in it:
- A trend channel cannot be too shallow (0-25 degrees) otherwise it is acting more as a correction. This is usually a corrective channel, flag chart pattern, or sideways range;
- A trend channel cannot be too steep (45+ degrees) otherwise it is not sustainable in the long run. This usually impulsive price action on a higher time frame and price corrects the steep price action before a trend continues in the long run;
- A trend channel must have a sustainable, well balanced equilibrium that is sustainable in the long run (price remain in the boundaries of the channel for longer period of time);
- A trend channel should be completed on a time frame that is 1 or 2 time frames higher than chart of entry and should not be lower than a one-hour chart.
EXERCISE: practice the above by drawing 1 trend channel within the range of a correct angle. Post the chart down below.
TREND LINES AND CHANNELS INTERACTION
Trend lines can be drawn in every environment (trend, reversal, range), whereas a trend channel is drawn during a trend. Within a trend channel trend lines can help:
TREND CHANNEL CHARACTERISTICS
Where are the hits?
Besides having the correct angle, a trend channel must have 3 hits before it can be considered an “established channel”; otherwise it cannot be considered an official trend channel. A trend channel with 2 hits is only a potential trend channel. The channel however does not need 3 hits on both sides (top and bottom):
- In an uptrend channel there must be 3 hits on the bottom (but not the top);
- In a downtrend channel there must be 3 hits on the top (but not on the bottom);
- Although 3 hits is only required on 1 side of the channel, it is true that a channel with multiple hits on both sides is better. This is valid for both the top and bottom lines;
- There is no minimum number of hits needed on the top of an uptrend channel and bottom on downtrend channel but having at least 1 hit is better.
The middle line
A trend channel should also have a middle trend line (exact middle point of the channel) which is “respected by price”. A Forex trader can be more assured that the trend channel they drew on the charts is acceptable when price stops, retraces or reverses at the middle point, which confirms that price “sees” the equilibrium line of the trend channel. In fact, some traders refer to an 80% chance of price at one point or another returning to the middle line of the trend channel. Although in my opinion this percentage calculation is difficult to prove, I do agree that traders should be cautious in trading:
- Pieces of price action that are too far above the middle line in an uptrend channel and
- Pieces of price action that are too far below the middle line in a downtrend channel.
The quarter lines
If you need more help when to go long or short OR take profit OR search for reversal trades, then using the quarter lines within a trend channel could be very useful. A quarter line splits the trend channel in four equal parts or in other words, it adds another line in between the middle line and top/bottom lines.
For an uptrend the quarters of the channel mean this:
- Bottom quarter – excellent long potential;
- 2 middle quarters – bouncing area for uptrend continuation;
- Top quarter – take profit zone & area for reversal traders.
For a downtrend the quarters of the channel mean this:
- Bottom quarter – take profit zone & area for reversal traders;
- 2 middle quarters – bouncing area for downtrend continuation;
- Top quarter – excellent short potential.
EXERCISE: practice drawing a trend channel and add quarter and middles to the chart. Post the chart down below.
NEXT WEEK’S GOAL
Next week’s article (part 5) will review what kind of problems trend lines traders often run into and how these can be solved. Don’t forget to post the exercises down below. Thanks for sharing this article and wish you Happy Trading and a nice weekend.
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