Stock traders using technical analysis and chart patterns have been channeling stocks as far back as rice traders using candlestick charts. Channel trading is a valuable instrument that can help traders capitalize on market trends by setting precise points at which to buy or sell shares. It can also help investors set stop-loss or take profit levels. Stock channeling is most commonly used for short-term or medium-term trading.
What Is Stock Channeling?
A channel is a trading range that exists between two parallel trending lines. The upper line connects the highs or peaks, while the lower line connects the lows. The channel is the area between these lines.
Essentially channeling stocks have their prices trapped between two parallel lines of support and resistance. If the channeling stock is rising it’s called an ascending channel. If the stock is falling it’s called a descending channel. If it is remaining even it is called a horizontal channel.
Stocks fall into these channels because both buyers and sellers are near agreement on the fair prices for the shares. Traders take advantage of the situation by continually buying on the support side of the channel (with a stop loss just under the channel) and selling near the top of the channel using a trailing stop loss in case of a breakout situation instead of a hard market order to sell.
Reading The Channel
Channeling stocks is a trading strategy that can help the investor know when to buy or sell stocks, or when to hold. When the stock price reaches the upper line of the channel it usually indicates a good time to sell. If it is in the middle it may be best to hold, unless it drifts within a middle area of highs and lows, in which case it may be time to create a more narrow channel. If it hits the bottom line of the channel it indicates a good time to buy if the channel isn’t descending.
When a channeling stock begins to narrow in range over time it is often a sign that a stock is about to break out of the trend. When you notice the highs are getting a little less high and the lows are getting a little less low the channel may be narrowing. If the channel becomes too narrow it may be time to get out and look for another method or stock for the time being. This is known as a converging triangle pattern.
It is generally thought that the width of a channel represents the magnitude that the stock will break when it does break the channel. So if you find a wide channel you will have found a great opportunity to earn because your swings will earn more profit per trade, plus the breakout will carry more momentum than normal, earning extra returns.
A good indicator of a channel ending is when the longer term time frame of the same stock shows a strong progression in one direction or the other. If a stock wants to go up over the long run, a short term channel will not keep the stock price down for long. It’s not worth fighting the wave.
Finding Channel Patterns
This strategy won’t work for all equities. You can only use this technique if the stock has an existing channel within its chart. One way to find channeling stocks is to look at a lot of stock charts to find channel patterns. Another option is to use trading software that recognizes channel patterns. There are also services available online that use computer programs to find stocks that are in currently in channels and they will email the results to you.
It’s nearly impossible to publish channeling stock picks because they could change before you ever read this article. A better place to start is industries which are cyclical in nature and therefore their stock prices tend to cycle with the returns of the business. The auto industry is famous for boosting in the summer and fading into the holiday season. The retail model usually doesn’t hit it’s most profitable time until Christmas so you could expect some type of cycle until the Holiday buying spree season. Agriculture is definitely linked to the seasons. Find a cycle that makes sense to you and that you can understand when an exception to the rule is on the horizon.
Back in the 1990’s Wade Cook wrote a book called Wall Street Money Machine creating a whole investment program around long term channeling stocks which he termed rolling stocks. The premise of his whole investing philosophy was lots of small gains earned greater returns than waiting for the large hit. He called this mentality the meter drop, which he discovered as a taxi driver. He added the extra boost to returns of short selling at the resistance levels instead of selling out. He also recommended using options instead of stocks or finding penny stocks that are channeling stocks. Most think he took the idea too far from a simple chart pattern tool. He ended up bankrupt and in prison for tax evasion.
Channeling can be an asset to any trader because it can help highlight the points at which to buy, sell or create a stop loss.