Trend channels are valuable tools for understanding where the market is heading. Often, the market follows these channels, providing a framework to better organize and understand sometimes overwhelming market movements.
An upward trend is defined by the chart showing higher and higher peaks at each turn, as well as higher and higher troughs at each turn. Similarly, a downward trend is defined by seeing lower peaks and lower troughs on the chart.
By connecting these troughs, channels can sometimes be formed.
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Below, an upward trend is shown, characterized by higher peaks and higher troughs. The price bounces off the bottom of the channel, and the trend continues.
In an intact trend channel, bounces against the bottom of the channel represent buying opportunities, here marked with green arrows.
The trend channel is drawn by connecting the peaks with peaks, and troughs with troughs, creating a channel. To trade with the trend, one can buy when the price hits the bottom of the channel, thus following the trend and securing a good entry price. The channel acts as a support point for the price, thereby offering good opportunities to move in the right direction and do so at a reasonable price level.
Trend channels also provide insights into when a trend might be ending. As long as the chart shows higher peaks and higher troughs and stays within the channel, the trend remains intact.
However, at some point, the price breaks through the trend channel, signaling a shift in sentiment and indicating it might be time to change direction. Some day traders use these channel breaks as opportunities to trade, as seen in the chart below.
Here we see the price of Bitcoin. The upward trend has lasted for some time, but at a certain point, the price breaks down through the channel, and this would be a sign that the price is expected to decline, and many will enter the market with the expectation of a downward move. When the price crosses down through the trend channel, it can be interpreted as a sell signal. See the circle.