What are the trading channels?
One of the most popular patterns in the entire trading industry is that of the trading channels.
According to most trading gurus they are very useful and would become an excellent weapon in your arsenal to become a great trader.
I honestly do not see that these channels will give us any comparative advantage per se, from the start.
But I do not want to say that it is bad to be able to see that in the big price movements we can always observe that they move within a kind of range.
The most famous and well known channels are undoubtedly the Bollinger bands, of which I have already spoken on one occasion.
Another type of channels that are less elaborated but not less effective result from applying moving averages vertically displaced in a given percentage or price.
In this way we will obtain a graph with the price in the middle and two moving averages that will wrap the instrument above and below.
This simple “indicator” clearly shows a series of occurrences that usually occur in the bullish or bearish markets, although it is much better in the first ones, because you would do better to leave the bears for others, unless you know what you are really doing.
Let’s see an example.
In this case, the shares of Apple, one of the most successful instruments of recent decades, which are characterized by a markedly bullish trend.
The importance of the uptrend in Trading Channels
In the case of Apple it happens that we have had a bullish or slightly bullish movement in a significant portion of the time for many years.
In this case what we have to look for is a bullish trading of said asset, without a doubt.
It’s like having two aces in poker. When you have the winning hand it’s best to continue betting, and strong, too.
In the case of Apple, the stock has risen almost 80% from a year ago (2018 by March).
If we apply moving averages with a deviation of 5% of the price above and below in said chart, and with a period of, for example, 15 days, we will see that the price is moving in a fairly disciplined manner within that range Envelope that these two moving averages have created for us.
If we look, the moments in which the price of Apple approaches or touches the lower moving average, turns out to be a good enough time to buy because in most of those cases it almost meant the end of the last correction.
In the case of the upper band we have almost the same, since most of the times the price approached or touched the higher moving average we had an acceptable opportunity to sell.
However, in the latter case, if we look closely, in the case of a bull market, we find many more problems than in the case of the “purchase” in the lower part of the price.
This occurs because clear bull markets, such as Apple, produce price movements in which it far exceeds the “upper limits” of the ranges, whether Bollinger, moving average or other.
This is intrinsic to the bullish behaviour of any asset.
Therefore, unfortunately, we will lose a large part of the benefits when we try to leave these assets in those sells.
For example, in the chart we can see how in February 2017, the price touched the upper part of the surrounding channel in the 125 dollars.
If we had bought between 105 and 108, which was the time that Apple quoted in the lower part of the channel, we would have obtained a potentially quite good operation.
The problem here is that after touching the $ 125, the price continued to rise to 155 and did not give us another “trading opportunity” until returning to the bottom with about $ 148.
As we see, we would have a good operation, but at the same time we would lose enough of its upward potential.
In addition, depending on the level of stop order that we had, we would have missed, or not, the first operation. Imagine that you bought at 108, and your stop was at 104. Well, a few days later they would have taken you out of the market since Apple dropped to 103.50.
Therefore, unless you had a stop loss of about $ 5, at least, they would have taken you out of the market.
If you had stayed you could have gained about 15%, however.
As we see, this trading is quite dynamic and somewhat more complex than it seems at first glance.
Buying the lower part of the channel does not guarantee that the price will not go down a bit more and take us out of the operation, even though afterwards we go up and see how, in principle, we were right.
For this reason, sometimes it is better to place stop orders somewhat looser, or even try again the same operation later.
As for the “point of sell”, in the upper part of the range, I have to say, that although it works quite well in a bull market, it is almost better to let the price run, and settle it later, for which it will do .
We must have enough courage and endurance, obviously. Otherwise we will be losing many points of the rise. This was something Jesse Livermore talked about a lot.
However, the “sell at the top” per se, is not a bad alternative.
Why did I say that in my case I do not consider that these trading channels are not the panacea?
Not so much because the concept behind them is wrong, but because an experienced trader is able to see these “channels” without needing to build any “indicator” and put more marks in them, already in itself, Sometimes, congested graphics.
In general it is easy to see when an asset is bullish, and it is easy to see when it has corrections.
What is not so easy is to hit the predictions in a significant percentage and earn percentage points.
How do you know if asset X is bullish in the first place?
Well, like the previous thing, you do not need many indicators to see it either.
Just looking at the graph should suffice, but just in case you want some extra information to help you a bit, we could see the long-term Apple chart with a simple 150 or 200 day moving average.
In the chart, we can see how a 150-day moving average, for example, in Apple, helps us to see that effectively, most of the time the price is above it, and if our trading channel signals are given above it, there is a pretty good chance that the bull market continues.
The bad thing about the bull markets is that they never last forever, and eventually we will have a moment when the price will fall very strongly below that moving average.
In that case we would have to stop applying the “bullish” envelope channel concept.
When the bullish channel ends, you should think about making the bearish channel, but in that case I remind you that doing bearish trading in stocks is very complicated, not only because these movements tend to be less frequent, but because the way in which the price moves makes our “buy and sell efficiently” strategy in the channel seriously compromised.
Maybe it’s something that could be different in Forex or other instruments, but even so, the difficulty of applying those strategies is high.
What happens to the surround channel if we have a side market?
In this case we would have to buy in the lower parts of the channel and sell in the upper parts of it would be a very good strategy.
The bad thing about the ranging markets is that we do not know that we are before one, until it is about to end.
That is to say, at the moment when we can say that we have a side market, the most probable thing is that half of it has already been gone, so it is difficult to know when is the best time to apply a suitable trading for them.
For example, in the side market of the DAX in 2014, it is difficult to see that we are fully in one until well past half of the year.
Furthermore, if for example, we were guided by the 150-day moving average, we would see that even applying the bullish envelope channel strategy, we could continue to have successful operations in the first months of 2014, buying the lower range and selling the higher range. Which becomes more complicated when the market turns around the long-term moving average and begins to fall a bit more, as in the second half of that year.
This, however, changes a lot depending on the assets, temporality and conditions.
In this case of the DAX I applied a deviation of 3%, instead of Apple’s 5, since there is a volatility difference between both assets.
That difference in volatility is even greater between stock exchange and Forex, as for example we see with the case of the AUDUSD, where I have to put a lower deviation.
In the case of this asset, there was an important lateral market from mid-2012 to mid-2013.
On that occasion, with a deviation of 2%, we can see how the zigzags of the market were perfect, and a strategy to buy near the bottom and sell near the top would have given us a very good result.
As you can see, also, another rather simple way to see these side markets is by applying a few lines of supports and simple resistances.
With this we can see that in the end most of the trading indicators are related to each other.
This is for a simple reason: the vast majority depend on the price, and the envelope channel does not escape this fact.
Sites like Investopedia tell us that to operate this type of channel we need 4 points already established, in the sense that if it is an upward channel will have “maximum” points higher than the previous ones and also with the minimum, producing the opposite in a bear market .
This interpretation is also valid to see what trading with these “channels” consists of.
In the end this is about the same as always: “buy cheap and sell expensive”.
This is easier said than done, though.
Regards and good trading.
Original article: Identificar canales envolventes en trading