When students are taught the concept of parallel lines in geometry, instructors often ask their classrooms to envision train tracks receding into the landscape. Horizontal channels can be imagined in a similar fashion, where two trend lines form to denote equal highs and lows in an asset’s price chart. In other words, horizontal channels help illustrate when buying and selling pressure are contained within a specific range with no prevailing direction, i.e. nothing to significantly rally bullish or bearish traders.
With trend channels, the upper line represents the resistance level, or ceiling, while the lower one represents the support level, or floor. Before establishing a horizontal channel, an asset’s price must record at least two instances of hitting these high and low values to determine if a pattern exists. The strength and reliability of these trend lines in turn depend on how many times an asset’s price reaches and deflects from the floor and ceiling of the established channel.
Asset prices, sometimes referred to as “sideways” market movement, are fixed in horizontal channels, and in fact, fluctuate between these peaks and lows. This results in “choppy” or “zigzagging” charts that bounce between the resistance (high) and support (low) levels. Over time, this can result in price consolidation as highs and lows spiral towards a mean value, or the market gains enough momentum upward or downward to break the cycle.
Trading within the horizontal channel
In an established horizontal channel, the most common strategy is to buy an asset when its price reaches the support, and to sell when it reaches its resistance. Since horizontal channels suggest a price is more likely to rebound from these levels than breakthrough, this strategy is a derivative of the age-old “buy low, sell high” mindset.
Some traders are prone to enter the market only after a rebound. However, it’s still important to watch for any signs of a potential breakout. Here, users can opt to place a Stop Loss above the upper line, or below the lower line to mitigate the risk.
The examples below help illustrate how these scenarios can play out in practice.
In the chart above, the DASH price is trading in a $117-$154 range, with several recorded data points showing the price’s commitment to this channel. In this case, traders may choose to open a Short Position when the price reaches the green line, in anticipation of prices dipping back toward the support. Additionally, they can elect to deploy Stop Losses above the resistance level, or below the support line, to help protect against potential price breakouts.
When the price is meandering within the horizontal channel, traders will closely monitor each movement, and respond accordingly as it approaches the resistance or support line. The goal for many users is to be ready for a potential breakout.
Horizontal channel breakout
Due to the “sideways” price movement associated with horizontal channels, many traders view these periods of relative stability as a temporary pause in a prevailing trend. This can also be interpreted as a “calm” in price activity before a major upward or downward trend resumes. Because of this, horizontal channels are often considered neutral patterns that could break in either direction.
When the price breaks above the resistance level, it is a potential signal for further upward movement. Conversely, if the asset value breaks below the support level, a sell signal is generated. Depending on the momentum behind these initial swings, an asset can stand to see varying degrees of bullish and bearish fluctuations in its price.
In the chart above, the red arrows indicate where the DASH price broke out of its support level, only to find itself in another horizontal trend channel. In this scenario, the breakout was accompanied by an increase in trading volume, which suggests that bearish participants have stepped up pressure near the support level. Price breakouts are often convenient entry points for traders looking to benefit from the current market direction.
To confirm if a breakout is valid, users will rely on technical indicators, such as trading volume, to determine if the market is poised to continue its trajectory. Other technical analysis tools include relative strength index (RSI), stochastic, or average directional index (ADX), which can be used to determine trend strength and isolate potential turning points.
Since many factors can inform the rise or fall of an asset’s market valuation, it’s important to cross check any hunches with thorough research and analysis. In turn, conducting a clear-eyed personal risk assessment before responding to the latest movement can also help keep emotions in check and work to avoid getting carried away by the market.