Channeling Stocks
Channel stocks are stocks that trade within a certain range between high and low price points for a period of time and may become predictable over time. Instead of the investment policy of buy and hold, channeling stock investors finds opportunities of buying and selling the same stock again and again.
They have a clear and identifiable historical movement pattern in waves, which become predictable. Two lines can be drawn across the peak and along the bottom. The area between these lines forms the channel, with the upper line denoting the resistance level and the bottom line the support level. The break out points in the channel indicate bullish (in case of upward trends) or bearish (in case of downward trend) signals.
The movement of these stocks forms a pattern of a tube or channel. The movement may be upward leaning or non leaning. When the stock reaches the bottom point of the channel it is ready to buy, and when the stock reaches the top of the channel it is generally sold. Such stocks are also termed as rolling stocks.
Investments in channel stocks are for the short term, often giving the investor an opportunity to make huge gains on the same stock again and again.
Channel Trading:
Channel trading is a powerful trading technique that is based on capitalizing market trends.
A channel stock will have limited price movement and will be bound by a well defined trading range. There is resistance above the channel and support below it. Sellers lurk at resistance, thus preventing the stock from reaching new higher highs. Buyers lurk at support, thus preventing the stock from touching lower lows. This results in horizontal price action rather than uptrend or downtrend.
How to Locate a Stock:
The technique of channel trading can be applied to only select equities that show an existing channel in its chart. It is essential for the underlying channel to have at least four contact points for the channel to be of use for trading purpose. This channel stock can be located in three ways
Look through the price charts manually to locate channel patterns
Utilize a software that automatically recognizes channel patterns
Subscribe to companies providing the service of giving a list of stocks where channeling can be used
How to Create a Channe:l
The steps to be followed in creating a channel are
Locate a relatively high and a relatively low point in the chart and begin the channel there
Locate another subsequent high and low point that follows any of the patterns given below
o Ascending channel higher high and higher low
o Descending channel lower low and lower high
o Horizontal channel horizontal highs and lows
Draw two trend lines one joining the two highs, the other the two lows. Note that the lines are almost parallel
These two lines will now form the basic channel once there are at least two contact points with the upper channel and two with the lower channel. The reliability of the channel is increased if there are more contact points
How to trade using the channel:
Once located, channels can be easily used to trade systematically.
Locating Buy and Sell Points Channels help locate the optimal points to buy and sell. The standard rules are
o Sell when the price hits the top of the channel
o Hold when the price is in the middle of the channel
o Buy when the price hits the bottom of the channel
However, it needs to be understood that if the price breaks through the top or bottom of the channel, then a new channel is established and if the price drifts between the channels for a long period, a new narrower channel must be established.
Determining Stop loss and Take profit points Channels provides opportunities to add caution to the trading system in the form of stop loss and take profit points. The standard rules are
o If the stock has been bought at the bottom of the channel set a take profit point at the top of the channel.
o Set a stop loss point slightly below the bottom of the channel, allowing room for some volatility
Channel Trading Strategy:
The key to channel trading is to get in and out of the stock at the appropriate price level. Most investors prefer to buy within 20% of the low and sell within 20% of the high. If one were to wait for the absolute historical high or low one will often miss out on profits. So try and fix the entry and exit point before buying the stock. You may also fix your loss tolerance limit. As in the case of any stock a channel stock can also have its share of good and bad news. Incase of bad news the stock may dip below its historical low. Incase of exceptional good news it may exceed its historical high. Investors can put in a stop loss order. This will instruct the broker to sell the stock at a specified point in order to minimize the losses in case the stock shows a downward trend. Similarly a take profit point should be predetermined to sell and book profits in an upward moving market. It is easy to get carried away in a rising market and then lose all the potential profit by some disruption. So greed should be avoided and discipline practiced to really benefit from Channel trading.
Conclusion:
It cannot but be accepted that channels provide one of the most accurate methodology for trading. By encompassing the stock price movement within two parallel lines, this chart can provide the exact points for buying or selling the stock as also give signals for stop loss or take profit points.
Before starting channel trading it is a good idea to do dummy trades for a certain period of time, this will give the investor the necessary confidence and discipline to be equipped for channel trading.
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