Plot trading channels to navigate twists and turns

Philip Salter
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CHANNEL trading is a stalwart technique for spread betters – a leading light to help traders set the right course in volatile markets.

David Jones of IG Index explains that “channel trading is just an extension of trading with the trend.” Jones thinks it is “a sensible way to approach a market.” Because markets can tend to swing in similar ranges up and down, he says “using a channel can help estimate how far away a market could move from the trend.” Jones adds “It’s very useful for spread betting, as many clients aren’t just trying to jump in and out in the very short term for a few points every day, but are looking to run their trades for days and sometimes longer to capitalise on the trend.”

Jones is pragmatic in his advice to traders: “Like any technique, there is no holy grail and it is not going to work all the time, but it has at its core the principle of trend following, that makes it worthy of consideration.” He is adamant that markets trend over all sorts of time frames, so trying to identify and follow these can stack the odds in your favour.

Trading channels can run for a long time. Angus Campbell of London Capital Group notes that a classic trading channel formed in the FTSE 100 throughout 2011, until the break out to the downside in August. Campbell says “this channel provided traders with fantastic opportunities to sell the highs and buy the lows, as the index continued to repeat itself by trading within the 5,800 and 6,100 trading range.” Jones notes that, over the last couple of weeks, sterling-dollar is a reasonable recent example of a channel. He says “it’s not perfect, but these things seldom are in the real world.” Jones says “using a channel here would have helped identify the trend and help refine an entry point.” Don’t let the perfect profit be the enemy of the good income. “Channels are also useful,” says Campbell, “because they can signal a break out in either direction.” He notes a break out of a channel can often lead to a sharp move in the direction of the break out – as we saw this August with FTSE 100. This is the time to get on the trend.

Although nothing lasts forever, once a channel has been established the chances of it continuing are increased, as traders confirm their biases. It can be useful to note the number of times the price has hit either the top or bottom of your channel, to see how strong the channel is in which you are swimming. Of course, it will break out at some point and then you shouldn’t try to swim against the tide as the current is likely to be strong.

In essence, channel trading is simply the drawing of an upper and lower band, beyond which the odds of the price moving are statistically less likely than the status quo. When the price does break out, you might get stopped out if you are the wrong side of the river – but this isn’t the time to jump ship. Now is the time to grab a new boat and take this tributary as far as it will take you – using a trailing stop to lock in your gains.