Further talk on spike plus channel trends
This lesson will cover the following
- The different appearance of channels
- Trading channels against the trend
- Market behavior during the channel phase
In our previous article we already said that a trend reversal may occur with a spike in the opposite direction. We should note that there is also a chance the market may reverse its direction, in case a trading range occurs after the spike. If a spike to the upside occurs, followed by a trading range, in almost 30% of the cases the breakout will occur from the lower area of the range and not from the top. The breakout may appear as a huge bear move (spike), but in many cases it is a moderate-sized bear trend bar, after which a bear channel follows.
The channel phase
In case a channel is formed, the most appropriate decision is to make entries only in trends direction. At times huge swings may be present within the channel, that may provide experienced traders with the opportunity to scalp against the trend, as the channel continues to develop. However, it is a risk-on move, because channels may extend more than one supposes and they always seem to be attempting to reverse. A lot of bars with large wicks, trend bars in the opposite direction and bars with large overlap may be present, but they are all a part of the existing trend, so a premature entry against the trend may turn out to be very expensive for a trader.
Channels may appear in different ways
In some cases trading days may have trends, beginning with a sharp move (huge momentum), followed by a channel with lesser steepness, that develops during the remainder of the day. Sometimes the channel may accelerate and not appear as linear, but as parabolic instead. In other cases, the channel can be of lesser momentum (and appears to be flatter). Either way, the beginning of the channel is tested at a later time during the day, while the test can be followed by a trading range. What is of utmost importance for a beginner is, that if the channel appears to be very tight, it should be traded only in the direction of the trend. This is so, because pullbacks may not go at a distance far enough, so that a profitable trade against the trend can be initiated. In rare cases the channel is broad enough, so that decent trades in both directions can be taken.
Trading channels against the trend
If a trader considers to enter the market in a countertrend direction, these entries should be made after a breakout from the channel actually occurs against the trend. In this case the move against the trend may test the very beginning of the channel and form a trading range. Although a channel can be considered as a sloping trading range, as we already said, it can also be the first leg of a larger trading range. The reversal may occur in proximity to the beginning of the channel.
Let us imagine the following scenario. A sudden move to the upside is followed by a pullback and a bull channel. This bull channel represents the first leg of a trading range, that is about to form. Prices may retrace to the lower area of the channel and attempt to create a double bottom bull flag (second leg). This may be followed by a move up, thus, it is the third leg in the forming trading range. After this move up, a trader should look for other setups, as the spike plus channel pattern does not have a predictive value anymore.
Market behavior during the channel phase
Another important moment to note is that price behavior during the channel phase is the same as in any other channel. Almost every spike plus channel bull setup has a breakout through the lower area of the channel, while the test is close to the bottom of the channel. A common reversal setup is a three-swing price pattern within a channel, that tends to have a wedge shape. The third swing price overshoots the trend channel line and leads to a reversal (in the form of a large reversal bar). However, the reversal may not be so clear most of the time, so it is best to wait for the pullback after the breakout.
In case a breakout below a bull channel occurs, a trader should wait for a pullback to a higher high, while if a bear setup appears, he/she may enter in a short position.
In case the price falls to the lower area of the channel and a buy setup appears, the trader should wait to enter long at the bounce following the double bottom bull flag.
The case with steep channels
If a channel has considerable steepness, the spike and the channel elements together appear simply as a single spike, when viewed on a higher time frame chart. This spike will usually be followed by a channel on that same time frame.
Sometimes a spike, that consists of several bars, may appear, but no channel may follow it. The last few bars of the spike may show certain overlap between them, which may actually appear as a channel, when viewed on a smaller time frame.