Channeling is basically taking the slope of a particular trend, whether it is up or down. This pattern is used to determine if a stock is in a trading zone or if a new price level is being created.
Official Terminology
Bearish Price Channel – When the slope of the channel is downward. Signifies stock is losing price.
Bullish Price Channel – When slope of channel is upward. Signifies stock is creating higher price.
Overall Concept
The main idea behind a price channel is to determine what the trend of a stock is. It is a fairly simple analysis that uses trend lines to distinguish the pattern. Channels can be up, down, or sideways.
Drawing a trend line between the highs and a parallel line that connects the lows creates the pattern. While the stock stays within the boundaries of the two lines, the stock is considered in a trading range.
The bottom line acts as a support, while the top line is the resistance. A break of either line means the stock is more than likely ready to create a new price level. Like with most patterns, the stronger the volume on the break the better odds of the stock following the pattern.
Concept in Action
From the chart below, we can see how channeling works.
Basically we are creating a box the stock seems to stay in. In this example, the stock is currently experiencing a bearish price channel. For us to buy into the stock, we would either wait for the stock to hit off the support (bottom line) or break above the resistance (top line). For us to sell, we would wait for the stock to bounce of the resistance or break below the support.
In this case the stock managed to break through the resistance, which eventually led to higher a higher price. That resistance then became the support.
Important Reminders and Notes
1. A stock is considered within the trading zone when sitting between the two lines.
2. A break of the pattern on both either sides indicates a forming of new price levels.
3. The more times a line is hit by the stock; the more significant the line.