All you wanted to know about channel patterns

A channel is a combination of trendlines that helps traders identify the price move and even assists in determining the target levels to optimise profitability. It is a line drawn on respective highs or lows of trendlines to exhibit the price movement. Over the years, trendlines have facilitated in showing the support and resistance levels to build a profitable trading model.

Avdhut Bagkar | Business Standard
13th November

Types

Ascending Channel is a formation pictured as an upward sloping trendline. This pattern is quite familiar as “Rising channel Pattern” which demonstrates the gradual rise of stock prices with healthy corrective moves in Higher high, higher low format. This structure represents two trendlines named 'upper rising trendline' and 'lower rising trendline'. The price rallies within this channel in a steady momentum. Recognising this channel provides a greater edge in trading and profitability.

Descending Channel is a formation that shows price moving in a downward sloping channel. Herein, the upper falling trendline represents the resistance and the price continues to make lower lows. The formation exhibits a negative trend with bears gaining hold of the market breadth. On the upper falling trendline, the market participants intend to short/ sell the stock with a view to buy it back near the lower falling trendline. The scenario stays put till the price respects these trendlines.

Horizontal channel is another word for “consolidation”. In this, the stock price fluctuates in a range that takes a rectangular form. Herein, the price scales highs and lows nearing their previous levels, suggesting buying and selling pressure on either side of the range, reflecting a flat or sideways movement. This pattern attracts market participants as the stock price is likely to soon breakout on either side. That breakout move provides substantial opportunity to gain quick returns.

How to maximise the benefit?

One of the parameters that help recognise a potential breakout is 'Volume'. One needs to clearly ascertain the volume structure to gauge the supportive strength and interest of the market participants. Wild volumes means volatility, which obviously hinders the price from reaching the expected or target price.

Suppose during the formation, volume shows sustainability at low levels and the stock gives a positive breakout, then the pattern is expected to perform well and reach the target price without much noise. During the breakout phase, volumes need to show an added interest.

Relative Strength Index (RSI) is a technical oscillator that determines the strength, integrity and the momentum of the stock. It is plotted on the chart with a value ranging from 0 to 100, which assists in determining strengths at varied values. Normally, when a stock trades above 50 value, it is recognised as having a positive outlook. On this scale, value over 70 is considered as overbought and below 30 as oversold. On a breakout, if the RSI is in the range of 50 to 60, it indicates a potential upside.

Also, moving averages have a great role in the channel breakout. Having a positive crossover of significant moving averages during the breakout can trigger a furious rally in a stock.

Disclaimer: This information is from a third party—Business Standard—offered through a tie-up to Kotak Securities customers. Click here for complete disclaimer.

The analysis has been done by a Business Standard reporter who is a certified technical analyst. The analysis does not represent the views of Kotak Securities.

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