Channels: trade inside the channel or trade the breakout

You've learned to draw a trendline under the lows of an uptrend. Now draw a parallel line through the highs and you get a channel. Price then moves inside a sloping corridor, with a floor and a ceiling that move together. It's one of the most useful structures in trading, because it gives you both a direction and zones where you can act.

How to draw a channel properly

You draw an ascending channel in two steps. First, the trendline under at least two rising lows. Then the parallel line, placed on the high between those lows. If a third point touches either line, the channel is confirmed: lots of traders can see it, so it's more likely to do its job.

• Ascending channel: higher lows and higher highs, both lines slope up. Favour buys near the bottom.
• Descending channel: lower lows and lower highs, both lines slope down. Favour sells near the top.
• Horizontal channel: this is a range, with flat support and resistance. You can trade it both ways.

Approach one: trade inside the channel

In an ascending channel, the most natural strategy is to buy near the lower line and aim for the upper line. You're trading with the trend, with a logical stop just below the channel. Your potential profit is roughly the width of the channel, minus a safety margin.

Selling the upper line of an ascending channel, against the trend, is much riskier. Price can break out to the upside and accelerate. If you do it, it's usually for a short target, around the middle of the channel, with a smaller position. Many traders simply refuse to trade against the slope.

Approach two: trade the channel breakout

Every channel breaks eventually. When price closes clearly below the lower line of an ascending channel, the sequence of higher lows is broken. That isn't necessarily a reversal: the market may simply move into a range. But the trend that let you buy the dips is gone.

The most cautious way to trade a breakout is to wait for the retest. Price breaks the line, then comes back to touch it from the other side. If it holds in its new role (old support turns into resistance), you enter with a stop on the other side of the line. You'll miss some breakouts that leave without coming back, but you'll dodge a share of the false breaks.

• Breakout with the trend (out of the top of an ascending channel): this is an acceleration. It's often dramatic, but it can burn out just as fast.
• Breakout against the trend (out of the bottom of an ascending channel): this is a warning. Confirm it with a new low below the last swing low.
• Common target: project the channel width from the breakout point. It's an estimate, not an appointment.

Read what price is doing inside

A healthy channel shows clean bounces off the lower line and highs that reach the upper line. When price can no longer reach the top of the channel and turns around in the middle, buyers are losing strength. That sign of exhaustion often comes before a break to the downside.

Mistakes to avoid

• Forcing the lines: if you have to ignore half the candles to make the lines fit, it isn't a channel.
• Redrawing after the fact: shifting the channel after every break so it stays valid means refusing to see that the structure has changed.
• Forgetting the higher timeframe: an ascending channel on the 15-minute chart may just be a bounce inside a daily downtrend.
• Ignoring the news: a central bank decision or an inflation print can cut through a channel in a single candle.