Chapter 15
Technical Trading Strategy: Channels

Channel trading is a less exotic but popular trading technique for currencies. The reason why it can work is because currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. By reviewing a few charts, traders can see that channels can easily be identified and occur frequently. A common scenario would be channel trading during the Asian session and a breakout in either the London or U.S. session. There are many instances where economic releases are one of the most common triggers for a break of the channel. Therefore, it is imperative that traders keep on top of economic releases. If a channel has formed and a big U.S. number (per say) is expected to be released, and the currency pair is at the top of a channel, the probability of a break is high, so traders should be looking to buy the break out, not fade it.

Channels are created when we draw a trendline, and then draw a line that is parallel to that trendline. Most if not all of the price activity of the currency pair should fall between the two channel lines. We will seek to identify situations where the price is trading within a narrow channel, and then trade in the direction of a breakout from the channel. This strategy can be particularly effective when used prior to a fundamental market event such as the release of major economic news, or prior to the “open” of a major financial market.

Here are some rules for using this technique to find long trades:

First, identify a channel on either an intraday or daily chart. The price should be contained within a narrow range.
Enter long as the price breaks above the upper channel line by 10 pips.
Place a stop at the lower channel line.
Exit the position when it moves by double the amount risked.

The short rules are the reverse.

Examples

Let examine a few examples. The first example is a USDCAD 15-minute chart shown in Figure 15.1. The total range of the channel is approximately 30 pips with the low being 1.2028 and the high 1.2056. In accordance with our strategy, we place entry orders 10 pips above and below the channel at 1.2018 and 1.2066. The order to buy gets triggered first, and almost immediately we place a stop order at the low of the channel or 1.2028, which means we are risking 38 pips on the trade. USDCAD then proceeds to rally and reaches our target of double the range at 1.2142. More conservative traders could exit half of the position when it moves by the amount risked, or 38 pips, and trail the stop on the remainder of the position.

USDCAD 15-minute candlestick chart for May 7, 2015 with arrows labeled Buy at 1.2066 and Exit at 1.2142. The candlesticks end at 1.21548. — **Figure 15.1** USDCAD 15-Minute Chart

*Source*: eSignal

The next example shown in Figure 15.2 is a 15-minute chart of EURGBP. The total range between the two lines is 12 pips with the low being 0.7148 and the high 0.7160. In accordance with our strategy, we place entry orders 10 pips above and below the channel at 0.7138 and 0.7170. The order to buy gets triggered first and almost immediately we place a stop at the low of the channel or 0.7160 for 10-pip risk. EURGBP then proceeds to rally and reaches our target of 20 pips or double the amount risked.

EURGBP 15-minute candlestick chart from May 11, 2015 to May 12, 2015 with arrows labeled Buy at 0.7170 and Exit at 0.7190. The candlesticks end at 0.71636. — **Figure 15.2** EURGBP 15-Minute Chart

*Source*: eSignal

Figure 15.3 is a 15-minute chart of the EURUSD. The total range during this four-hour period is 18 pips with a high of 1.1206 and a low of 1.1188. In accordance with our strategy, we place entry orders 10 pips above and below the channel at 1.1216 and 1.1178. The order to sell gets triggered first and almost immediately, we place a stop order at the channel high of 1.1206 for a risk of 28 pips. The EURUSD then proceeds to sell off significantly but only makes it to a low of 1.1132 before stopping us out a few days later. We chose to show this example because it explains why the more conservative approach of exiting half of the position when it moves by the amount risk is more desirable, even though it has worse risk reward. A move of 58 pips is sizable on an intraday basis and may be difficult to achieve. Whenever the risk is greater than 20 pips, it may be more prudent to exit half and trail the stop.