This week’s question comes from Panu, who asks:
I’m not sure when to use a trend line or a channel to monitor a trend. In my understanding, a trend line is used for an impulsive move and a channel is used for a corrective move. For example, if the big picture is down, I will draw a trend line from high to lower high. When price breaks the trend line and forms consolidation, I start drawing a channel as a bearish flag or a wedge in some cases. And when price continues to move down, I use a trend line again. Is my understanding correct?
It’s an excellent question and one that I believe deserves a healthy discussion.
I see it all too often – traders forcing a channel to fit when a trend line is more appropriate.
And the opposite is true too – traders using a trend line when there’s a valid channel forming.
So how should you determine which one to use?
The short answer is to see what makes sense. Draw a channel to determine if one exists. If it doesn’t, a trend line may be the best option.
Of course, there’s a bit more to it than that which is where today’s post comes in.
To address part of the question above, impulsive and corrective moves shouldn’t necessarily influence whether you draw a trend line or channel.
Instead, it’s about using the highs and lows to determine which tool is more appropriate regardless of whether the move is impulsive or corrective.
But before we get too far, let’s discuss a proper starting point.
Start With Trend Lines First
Like any endeavor in life, learning to trade Forex should be progressive.
There are certain techniques and strategies that a 10-year veteran will know and use that a beginning trader simply won’t have access to.
And that’s the way it should be. Trying to explore too much too soon can get you in a lot of trouble.
So if you don’t yet have experience using channels, my advice is to start with trend lines first. Once you get comfortable drawing and using trend lines in your trading, feel free to add channels to your arsenal.
But trying to learn both at the same time could become overwhelming.
When you stop and think about it, a channel is nothing more than two equidistant trend lines. So instead of having to deal with two levels you may be better off using just one to start.
Using trend lines in this manner can act as a stepping-stone into more advanced patterns and strategies.
See this lesson on how to draw trend lines correctly.
The Context Determines the Bias
So why use a channel instead of a simple trend line?
Apart from defining both support and resistance, a channel can give you insight into a market’s intentions. In other words, it offers a “big picture” view of the price action, allowing you to position yourself accordingly.
This is perhaps the most important concept when using channels. You see, the pattern itself has little meaning.
Sure, the market may bounce back and forth between support and resistance, but there’s no directional bias without accounting for the surrounding price action (aka the context).
Let me explain…
A bull flag pattern is always a descending channel. But a descending channel is not always a bull flag.
Similarly, a bear flag pattern is always an ascending channel. But an ascending channel is not always a bear flag.
Take a few minutes to let that sink in because it’s paramount. Without understanding these rules, you could find yourself stuck on the wrong side of the market more often than not.
Here’s an excellent example using the NZDUSD monthly chart.
Notice how the currency pair has carved out a large ascending channel that spans two decades.
There’s no doubt this is an ascending channel. But for it to be a bear flag it would need to have formed after an extended move lower, which didn’t happen.
So no, it is not a bear flag yet it is an ascending channel.
Now let’s look at another example of an ascending channel, this time on the NZDUSD 4-hour chart.
The ascending channel above formed after an aggressive move lower. So in this case, it’s also a bear flag pattern.
So you see, the most important part of any channel is not the pattern itself, but rather the context in which it forms.
I could make that argument about any price action strategy.
For example, a bullish pin bar on its own has little meaning. Place that same pin bar at key support within a strong uptrend, and you most likely have a buy signal.
The same can be said for the inside bar, head and shoulders, double top – the list goes on and on.
Context is key regardless of the time frame you use or the strategies you employ.
And channels, just like trend lines, always have a story to tell but the meaning behind that story is in the surrounding price action.
See What Fits and Use What Makes Sense
Keeping things simple is at the heart of everything I do and teach. And deciding whether to use a trend line or channel is no different.
One of the easiest ways to solve this dilemma is to use both and see what makes the most sense.
For example, if you come across a structure that appears to be a channel, grab the tool and draw it on the chart. It’s either going to line up with the price action or it won’t.
But either way, you won’t know until you start annotating the chart.
And don’t be afraid to get it wrong. Many of the levels I draw on my charts get modified at least once before I’m satisfied with the placement.
That’s what trading with price action is all about – using the market’s movement to find and validate areas of value. And you can’t do that without making a few mistakes along the way.
Just be sure that in your quest to find these areas you aren’t forcing levels to fit. If you have to spend more than 20 or 30 seconds to get a level to line up, it probably isn’t worth having on your chart.
After a few years of annotating charts, you’ll begin to see patterns without much effort. In fact, it’ll become automatic. The moment you see a chart your mind will start to plot levels for you subconsciously.
Once you’re at this stage, it becomes much easier to annotate, and you won’t find yourself second guessing your every move.
But like any endeavor worth pursuing, it takes thousands of hours of practice to get it right.
As Theodore Roosevelt once said:
Nothing in the world is worth having or worth doing unless it means effort, pain, difficulty… I have never in my life envied a human being who led an easy life. I have envied a great many people who led difficult lives and led them well.
When learning to use diagonal levels, it may be best to start with trend lines first. This will give you a solid foundation for drawing and trading with diagonals, thus offering a seamless transition into trading with channels.
Not all channels are created equal. Some offer insight into larger dominant trends while others have bullish or bearish implications such as the bull or bear flag pattern.
The context in which a channel develops is what gives it meaning and directional cues. One that forms after an aggressive move up or down is likely a continuation pattern.
Above all else, keep it simple. If a channel fits the price action in question, go with it. If it doesn’t, a trend line may be the better option.
And if neither makes sense, it’s usually best to move on to find more definitive price action to trade.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.