A trend channel is an extremely valuable tool that is simple to use. As in the Weekly chart of Newcrest Mining (NCM) below, the upward trend line (lower line) is drawn. If a parallel line can be drawn at the price tops, the Trend Channel is the area between the two lines. The second line is called the 'return line' because it marks a point at which a price is about to return towards the trend line.
A trend-channel is "confirmed" when there are three confirmed points acting as support or resistance. Therefore we can draw a simple up-trendline connecting the points labeled "A" and "B," and when the stock finds support and bounces off of point "C," the trendline is confirmed.
Trend channels most often appear in well traded stocks. It is usual for the volume to increase as the stock price reaches the bottom of the channel and the top of the channel. This generally indicates that there are supply and demand constraints within the trend channel. If the stock prrice price breaks the upper or lower trend lines, it could potentially signal a trend change. In the NCM example, the channel was temporarily broken in May and June of 2005, only to return to the channel once again.
How to trade the channel? After the share price has bounced from point “C” and any significant resistance/support lines have been breached, the CFD/option or share trader would be bullish until the share price hits and rejects the upper line. With the presence of an entry confirmation signal, an aggressive trader would be bearish for the short term. For a more conservative trader the share price would need to bounce off the lower trend line in order to trade with the trend.
An example of a more recent trend channel is the Daily Chart from December 2005 to May 2006 of Resmed Incorporated (RMD). This chart also includes the Moving Average Convergence/Divergence (MACD) indicator. As can be seen on the chart, the MACD indicator at crossover has assisted the short-term share and derivatives trader to confirm the move up from the bottom of the channel (highlighed in yellow on the MACD indicator) and the two ocassions in February and April, the softening in price as it hits the upper trend channel resistance.
