Trend Channels

A trend channel is an extremely valuable tool that is simple to create and utilise. Working with the weekly chart of Newcrest Mining (NCM) below, the bullish trend line (lower line) is drawn first. If a parallel line can be drawn at the price tops, the Trend Channel is the area between the two lines. The second line is called the 'return line' because it marks a point at which a price is about to return towards the trend line.

A trend channel is "confirmed" when there are three confirmed points acting as support or resistance. Therefore we can draw a simple up-trend line connecting the points labelled "A" and "B," and when the stock finds support and bounces off of point "C," the trend channel is confirmed.

Trend channels most often appear in well-traded stocks. It is usual for the volume to increase as the stock price reaches the bottom of the channel and the top of the channel. This generally indicates that there are supply and demand constraints within the trend channel. If the stock price breaks the upper or lower trend lines, it could potentially signal a trend change. In the NCM example, the channel was temporarily broken in May and June of 2005, only to return to the channel once again.

How to trade the channel?

After the share price has bounced from point “C” and any significant resistance/support lines have been breached, the CFD/option or share trader would be bullish until the share price hits and rejects the upper line. With the presence of an entry confirmation signal, an aggressive trader would be bearish for the short term. For a more conservative trader the share price would need to bounce off the lower trend line in order to trade with the trend.

An example of a trend channel is Resmed Incorporated (RMD) from December 2005 to May 2006. This chart also includes the Moving Average Convergence/Divergence (MACD) indicator. As can be seen on the chart, the MACD indicator at crossover has assisted the short-term share and derivatives trader to confirm the move up from the bottom of the channel (highlighted in yellow on the MACD indicator) and the two occasions in February and April, the softening in price as it hits the upper trend channel resistance.