What is this mysterious thing that you sometimes hear about? Well here's what happens, sometimes a stock gets stuck, and it's moving sideways between support and resistance. Anytime you see that happening; when a stock gets stuck in what we call a trading range, moving between support and resistance, we call that a trading channel.
What's great about a channel is it provides a predictable pattern of repeating behavior. This is something that you can anticipate and in time, of course, turns into something you can trade. You have a higher probability of making a profit with a couple of channels.
Let's take a look at this example.
You see how we rallied up into the $95 range, and we pulled back down to the $85 range. Then we went back up to $95 and again back down to $85, and we did this several times over. That's a channel, and you can easily trade this channel.
Trading channels usually happen after a big trend. You see below in our example; we had this nice trend. After the trend, you can see how it began to move between support and resistance, and there you can see the trading channel and your trading opportunity. Let's look at another example.
You can see how the stock traded up to about $105 and then on down to about $95, and it just kept going back and forth.
Here in this particular case, it's actually what we would call a downward channel. It's moving downward ever-so-slightly, but again you're trading between support and resistance in a bit of a predictable and repeatable pattern.
And here's another example, to drive the principal home.
You can see the channel is starting to form here across the bottom-living between about $37.50 and about $45 per share.
So, when a stock gets stuck, most people want to avoid it and say I don't want to touch that stock, because it looks like nothing's happening. But if you zoom in and you look a little closer to the price action, you realize that there's an opportunity.
For example, let's take a closer look.
Every time the stock gets up here to about the $126 to $127 range, it turns around and goes down. It's not always precise, a lot of people want these things to be precise, and it's not always that way.
Sometimes it's more of a zone or what I call a resistance zone.
So maybe three or four dollars or usually $1 or $2 range, where it kind of gets stuck moving sideways, but it trades up to a top-of-the-range, which is usually within about a dollar or two and then down to the bottom of the range, which I would call a support zone.
Support is where the buying pressure is going to show up, and resistance is where selling pressure is going to show up.
What you'll notice about this trade, while the typical trader wouldn't want to touch it, the active trader is getting in here and buying at support and selling at resistance. They're making $8 every time, and there are 4 or 5 opportunities to do that in this trade.
Now, this is not day trading, and I want to be clear, this is not day trading at all. This is simply buying at support and selling at resistance!
In this case, it's about three or four weeks that you're in the trade and then you get to your target.
So, the next question is, how do you do it? How do you trade a channel?
There are two ways to trade it.
So, look back to the example above and as it's bouncing up off support go ahead either buy the stock or buy the call option. If you're a little more advanced, you could do a bull put spread as well.
Then as it moves up to the resistance area and it starts to turn back down, you're going to short the position or buy some puts. And again, if you're a little more advanced, you could do a bear call spread.
That's how you trade the channel; you keep moving in and out of the trade.
I've just started to scratch the surface on this concept, but it's essential in learning how to become a great technical trader. Once you understand this concept, then you can apply it to all the rest of the techniques we teach you with your technical analysis.
If you want to learn more about this concept and others, we teach at TradeSmart; you can, of course, stayed tuned for more of our Trader's Tips!
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