At various times stocks will move in channels with identifiable highs and lows. These channels offer investors opportunities to generate profits in several ways. Investors use channeling stock patterns to identify buy and sell prices. The descriptions of rectangle bottoms and tops in Thomas Bulkowski’s book on Encyclopedia of Chart Patterns (Wiley Trading) support the definition of a channel for stocks.
Two parallel trend lines that connect the highs and lows bound a channeling stock pattern. A channel can trend up, down or horizontal. A horizontal channel can be a topping formation, a pause either in an up trend or down trend, or a bottoming formation depending on the trend before the channel formed. The appearance of a channeling pattern forms when stock prices oscillate between two trend lines.
Experienced traders may be familiar with channeling stock patterns known as bear flags and bull flags, which are short-term channels that represent a pause in the longer-term trend of a stock’s price.
The horizontal channel is one of the best performing channeling stock patterns. In the example below, Apple shows a horizontal pattern formed in late 2003. Two tops defined the resistance level. On the second move up volume was above average until the price encountered the prior resistance level. Support also has two low points where the price turned back up.
The price of Apple broke out through resistance with volume substantially above the 50-week moving average, a good sign that buyers were jumping into the stock. Investors who missed the move still had an opportunity to buy when the price pulled back to retest the breakout.
Bulkowski rates the horizontal channel, he calls it a “rectangle top, up breakout”, as the best performing bullish formation. While they do not all perform as shown in the Apple chart below, it pays investors to look for the horizontal channel stock pattern.
Horizontal channels form at the top of markets as well. In the chart below, we can see a horizontal channel formed at the end of 2007 on the S&P 500. This pattern helped to identify the end of the most recent bull market. Like most patterns, they are never perfect, though if you consider the price and volume patterns you can interpret what the chart is telling you.
The second resistance level tried to break up, however it did not have sufficient buying volume to do so. Next, the support level held and the market rebounded again. This time the S&P 500 could not reach the prior resistance level, another sign of weakness. The fourth time it reached support the index fell through and the trend turned down. The retest of the support level pushed up through the 1,400 former support level for a few days, though volume stayed about average indicating buyers were not committed to the move up.
The horizontal channel stock pattern offers investors an
excellent technical trading tool to identify good buy prices. These patterns
show up during a pause in the market either after moving down or after moving
up. When this pattern shows itself, during a pause in the market, investors
should be prepared to buy or short on a break of support or resistance.
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