In the forex market one of the main ways to make money is to capitalize upon confirmed trends in price. There is a widely used strategy in forex, used by many profitable systems known as the channel breakout.
Drawing Channels in Forex : Channels are straight lines which represent the range which a certain currency pair has been trading between over a certain period. The channel lines are easy to produce on a chart. To start with you need to find a good chart platform and start studying the chart for patterns of highs and lows. You need to draw a trend line across high prices which line up and make another line to show the low prices made during the same period.
Using this method you can determine a solid trend or range (let us assume using six months of data) in a visual format on the chart.
Channel Breakout: If the lines drawn on the channel are pointing upwards this means the price of currency is rising. In reverse if the price is in a down trend the channel lines will be pointing down. When the price approaches the upper or lower lines and crosses through them this is known as a channel breakout. Let me show you a picture to be clear.
As you can see on the chart above the price broke through the trend channel and proceeded to drop creating a very good opportunity to trade. However it’s not always as clear cut as this and to trade this method you need to have some strict stop loss ideas. A pattern than can occur quite often is known as a fakeout. This is where the price looks like it’s going to break from the channel but reverses back into it. A good rule of thumb is to AT LEAST place a stop loss at the opposite end of the previous bar or candle before the channel line broke.
You also have to remember that it’s really important to construct the channels properly, if you don’t match up the lines then you will see more false breaks than you should. This is why if you are considering trading this type of system it’s very important to get training or to spend a few weeks or months drawing the channels and paper trading the breakouts.
Managing This Idea: There’s good opportunity to make lots of money if you get the hang of channels. But you need a proper structure for your trading plan and have an idea of what size protective stop loss will fit with your risk and reward profile. This is important because when you have proper stop loss orders you’ll be able to manage the fakeout signals that occur and ultimately you’ll manage the small losses to eventually get the big profits.
Once you master this type of trade you can take it further by reversing on the fakeout. Basically if you get stopped out by a fakeout then reverse the trade back into the channel looking for a touch of the opposite channel line. This is quite a risky strategy, and one I will touch on in another article. For those new to forex, stick with the breakouts, master them and you’re trading will be transformed.