The Horizontal Price Channel Forex Trading Strategy is a trading strategy that is based on a price structure called a trading channel and it is used by all levels of traders-including beginning Forex traders.
To form a horizontal price channel, price action changes from a trending market into a market that is consolidating sideways.
Price action begins to plot an obvious support level and a resistance level. Given that markets spend most of their time consolidating (called a trading range) in a horizontal price channel, learning to trade price channels is a great addition to the toolbox of any trader – swing trader, day trader, and even position traders.
Keep in mind that on the trading time frame a trend may not be evident, horizontal price channels, as price traders from support to resistance and back again, can setup great trending trades on lower time frames. This is one reason why every trader should consider a multiple time frame trading approach.
What is A Horizontal Price Channel
Traders should know what a trending market looks like – the price action pattern of higher highs and higher lows for an uptrend – reverse that for a down trend.
A horizontal price channel may make the same trending pattern but it is done so with an obvious support and resistance zone. When price movement comes close to either extreme, price rejects and heads in the opposite direction.
You can see that price appears random inside of the price channel. For the most part, taking trades anywhere but the extremes of the channel can make for some painful trading. This is a one hour Forex chart so price looks more erratic. A daily chart will look more contained.
A horizontal channel forms from a trending market but can also occur after a large momentum move in price. Traders let the large move digest in the markets until it is time to either change the trend direction or the price channel is a continuation pattern appearing in the middle of a trend.
To make it more clear, consider that once a trending pattern ceases to occur, there is a potential for a horizontal price channel to form and we have a Forex trading strategy to deal with this common price action pattern.
When I see this type of price action, I become “on alert” for the potential of a range (channel) forming. When that happens, I can begin to utilize a Forex trading strategy designed to take profits in this type of market.
Trading The Horizontal Price Channel
A trading strategy designed for this type of price movement is straight forward. We are looking for price to move to one of the extremes and then will look for a reversal candlestick pattern to enter a trade.
It does not matter what time frame you look at to trade channels. I do suggest that traders use the multiple time frame approach through the following method:
- When price reaches one of the extreme points of the channel we look at a time frame 3-5 time lower than the trading time frame
- The lower time frame will give greater detail to see if whichever side, bulls/bears, brought price to the level, begins to lose control
This graphic shows two price action patterns that point to a reversal in price. Remember, this trading strategy does not just buy at support or sell at resistance – we need to see a price action reversal at the extremes.
The first reversal is the standard pin bar
Price has come into support and price probed lower. Perhaps some traders shorted at this level as a breakout but we can see that lower prices were rejected. This is the trapped trader setup, it is a reversal pattern and works great for our horizontal channel strategy.
One key for this type of reversal pattern is a long lower shadow. The deeper price probes and is rejected, the better
The second reversal pattern is virtually the same.
The difference with this pattern is we had two tests of resistance before price fell. If you placed a sell stop order below the low of the green reversal candlestick, you didn’t suffer any draw down.
Will your entry be a market order or a pending order looking for momentum to trigger you into the trade? These are questions you must ask before trading this strategy.
Stop Loss Placement
Eventually price breaks the high or low and the trend will continue. Where will you place your stop loss?
Placing your stop loss just over the pivot of the reversal candlestick makes sense – but could be too tight.
The market, as we’ve seen in the second example above, can retest the highs and it could even breach the high and still not invalidate the trade.
I think the high or low of the reversal candlestick is a good starting point but don’t put it just beyond it. Give yourself a buffer but remember that you may not always let your stop get hit.
If price breaks with momentum against your position, something could be changing in the market.
Don’t be a hero. Get out of the position and look to find another channel trading opportunity.
Should You Consider The Horizontal Channel Pattern Forex Trading Strategy?
It can be fairly easy to spot the channels and even more importantly, to ensure you have trading rules surrounding what a price channel means to you. Look above at the graphic again and consider a possible trading range is forming if price stops making a trending pattern.
Using daily time frames helps view the range extremes better than a lower time frame. If you ignore all price action in the middle of the price channel and only focus on the extremes, you increase your odds of a winning trade.
Using multiple time frames once price comes close to the extreme of the horizontal channel helps you spot reversals that you may be late to on higher time frame charts.
Your risk is well defined because you know exactly where you will be wrong – if price breaks the high of the reversal setup with momentum.
Your profit targets are easy to spot – they are the opposite extreme from where you took your trading entry.
The biggest risk is shorting just before price breaks out of the channel which will immediately give you a losing trade. That is why risk management is vital to the horizontal channel strategy but with smart money management, most traders should be fine.