A price channel is formed when a trend line connecting the highs and another trend line connecting the lows of candlestick price action can be seen to be parallel to each other. Price will stay within these boundaries until such a time when the price breaks either of the two trend lines as a result of strong market forces.
Channels can be formed in an uptrend or downtrend to give rising and falling channels respectively. They may also be formed when the market is sideways. The focus of this strategy is to catch the breakout move when it occurs, and use it to initiate a BUY/SELL or CALL/PUT trades, depending on whether American-style or European-style binary options are traded.
It is possible for the price action to break out in any direction, so the most important thing here is not to try to predict when price action will breakout. The most important thing to do here is to catch a breakout when it occurs, and then set the trade.
When is a breakout said to have occurred? If price breaks out of the upper trend line in a channel, it means that the candlestick has moved above and closed above that trend line. If the price action moves above the trend line but does not close above it, this is not a breakout, and therefore is not suitable for our trade strategy.
If price breaks below the lower trend line, it means that the price action has moved below and closed below the trend line. If the price merely moves below the trend line and still manages to find its way back up above the trend line by the time the candle ends the time period, this is not a breakout and is not suitable for use with this strategy.
It therefore follows that you must allow the candle time frame to elapse fully before determining whether a breakout has occurred or not. It is important to understand this concept when using this strategy, as the success of the trade depends on this.
The Trade Entry
More often than not, the price action will attempt to go back to where it came from. It will usually be resisted at the broken trend line, which is now acting in a reversed role. You can liken it to when an individual has stepped out of a house using an open door, and when the individual tries to step back in, the door slams shut to prevent re-entry. The individual seeing that the door is now shut against him, has no other option than to keep moving further outside.
If you can remember this analogy, you will remember the trade entry principles. The trade entry must be made at the point where the returnee price action is resisted by the trend line it just broke.
Drawing the Channel
You can use an MT4 chart to pick the asset to be analyzed and traded. There is the equidistant channel tool among the indicator pack. Take this tool and apply it directly to the price action, and adjust the lower and upper trend lines to match the candle lows and highs respectively. DO not be tempted to try to force the lines to match. Make sure that the trend line covers at least 3 areas where price has formed highs and lows to make the trace valid. Once you have done this, you are good to go on to the trade proper.
Example 1: Downside breakout on a lower trend line of a rising channel
The example shown below is the setup in a rising channel in which price broke the lower trend line to the downside.
In this situation, confirm the breakout of price action to the downside, allow the price action to try to go back to the trend line, and open the SELL (or PUT) trade at that point. The chart was a 4hour chart, so your trade expiry must be set to at least 12 hours or 3 candlesticks, so as to give the trade enough time to end in the money.
Example 2: Upside breakout on the upper trend line of a rising channel
In this example, we present a situation where there was an upside breakout of the rising channel. Notice how the channel tool has been used to connect at least three areas where price has attained highs or lows to get a perfect trace.
Again the candlestick is allowed to close above the trend line before the breakout is confirmed. This setup presents a situation worthy of note. If the candle closes a very short distance above the trend line, the trade can be taken immediately the next candle opens. The trade here is to set the BUY trade if using NADEX, or to set the CALL trade if using a European broker.
The chart used here is a 1 hour chart, so when setting the expiry time for the trade, you should allows several candlesticks to elapse so that you can be sure that your trade is in profit territory by the time the trade expires.
No assumptions must be made. Breakouts in a channel setup can occur in the direction of orientation of the trend (example 2), or in the opposite direction (example 1). All that needs to be done is to get the channel tool to work to identify channels, identify a breakout when it occurs, and then take the trade in that direction.
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