Sticking with the theme of trend from last week’s session, it’s time to further boost your arsenal with another technique – channel surfing, and needless to say we don’t mean with a TV remote…
Traders often talk about following the trend. And for good reason: trading in the same direction as the trend is far more forgiving in terms of entry price, since there is already a bias towards price moving in the trade direction. There is something very significant that’s less commonly talked about, though: the methods for defining the range of acceptable movement both with the trend and against for the trend to still be considered valid.
One of the most effective ways of doing this is to draw trend channels onto the chart using parallel trend lines, although this is a skill which is very open to interpretation, making it seem more of an art than a black and white set of rules.
Correct application of trend channels allows the user not only to define the strength of the trend via its angle, but also the volatility within the trend via the width between the channel extremes. This in turn gives the trader a useful set of tools for finding potential support and resistance, as well as the ability to clearly determine when a trend has ended and reversal signals should be taken.
So let’s take a look at the methods we can use to establish a trend channel and how the channel can help us predict potential trend targets and support levels.
- Identify a break in trend
- Identify two key reference points in the new trend, if the new trend is up we want to connect the initial low with the first higher low after a new higher high. If the new trend is down we want to connect the first lower high with the second lower high after a new lower low.
- We then copy the trend line that connects the two key turning points we place the copied trendline parallel to the first trendline using the low or high depending on new trend.
- This gives us the potential range for the emerging channel. With the channel now defined, this shows us that when price reaches the low of the bullish channel, we have a reasonable chance of a long trade entry.
- The rally is so strong that price gathers momentum and breaks through to the upside. This means that we need to re-evaluate the channel.
- By copying the trendline and overlaying from the swing high prior to the primary low in the new trend, we can get a reasonable idea of where the next resistance should be. Remember, we’re not really using these as entry points for trades since the trend is bullish, so we want to be buying, not selling. As such, these offer good suggestions for where to take profit if desired.
- As shown above, we have now defined the trend and the new upper limit of the channel is correctly predicting where the tops of rallies have begun to sell off.
- We can use a similar principal to establish new potential channel support by copying the primary trendline and over laying it against the small channel excursion we observed earlier in the price action.
Now, as we did last week, let’s look at how the LFX trading tool kit can help us use our new found trend surfing skills to extract profits from the market.
As with last week, my weapon of choice is the Psych Indicator. If we add the indicator to our charts we can see how combining the Psych Indicator with our trend channels offers excellent risk reward trade set ups with our new best friend the trend.
Stay tuned this week as we will be presenting a guide on how to use the Psych Indicator, which will explain how we can use this indicator to super charge profits!
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