Channel Trading Principles
When to buy and when to sell?
The Action Plan feature is designed to help you leverage the merits of channel trading more closely. This means you can build positions in a safer manner and hold those positions until the channel breaks. Using this mechanism you can cut your losses and allow your profits to run.
In addition, after practicing the Action Plan functions, it will become second nature for you to follow the trading wisdom of successful investment gurus. Among these wisdoms:
- Don’t build up positions in the wrong direction
- Don’t buy too late or when the price is already too high
- Don’t sell or short too early
- Don’t bottom fish
- Don’t do flattening
Before looking into the Action Plan functions, let’s see what to expect in using them.
Basics of Channel Trading
Watch and Trade: A safer way to build up position in a stock
Let’s say you spot a channel, whether newly formed or one that has been formed for a period of time, and you have done your homework and decide to establish a position in the stock. There is however no guarantee that the channel movement will continue. So, you still need to build up your position with care. To do so, you need to follow a channel trading mechanism.
You buy at the channel-buy-line and adjust some of the position at the channel-sell-line (since you don’t know if the price will move back up to the channel), and then buy more when the price comes back to the channel-buy-line. You continue this process until you build up an appropriate position. An appropriate position for an ordinary stock investor is suggested to be 10%~20% of the total assets you allocate for stock investment. This is equivalent to holding 5~10 different stocks in your portfolio.
The channel buy line is near the channel supporting line at the bottom. The buying point is triggered when the price movement bounces off the supporting line and returns to the channel buy line. You buy some stock whenever the price touches a channel buy point until you build up a proper position. You sell some stock at the channel sell line to protect yourself, as you do not know if the price will come back to the channel.
After this you build up the position you hold until the channel is broken, then close out the position. The system will issue clear and immediate alerts at optimal buy and sell points.
For short positions, you do the same thing: establish a (short-sell) position and hold, until the channel breaks. You have more position (short some stock) at the channel short line, adjust position (cover some stock) at the channel cover line, until you reach your preferred short position, and hold the position until the channel breaks.
When does a channel break?
The system offers channel breakup and breakdown lines. Users can adjust the lines with finger swipes. It is worth noting that channel breakup or breakdown has nothing to do with the cost of your investment (the price you bought the stock at). It has to do with the channel shape and movement itself. Default setting for breakup and breakdown lines are two-thirds of the channel width. The user can adjust the range to within 1/2~3/2 of the channel width.
When a stock price rises through the breakup line, it’s a good idea to buy or hold the stock. However, if the stock is overvalued, this breakup may be a warning sign that will trigger a sell off by institutional investors. If you do not already have an established position, and there is no fundamental breakup, it is better to leave the stock alone.
When the price falls below the channel breakdown line, it is generally a good idea to clear out the position. If and when the price rebounds, it is better to wait until it forms a channel in line with the previous channel.
In the previous example, say the stock breaks up and then comes back down, this signifies its time to take profit and sell off some stock. If after breakup, it forms a newer and steeper channel, hold until it breaks. In this example, if in the future the stock falls below the breakdown line, it means its time to clear out the position, or at least substantially reduce your holding.
In the system we use breakup and breakdown, as opposed to breakout or breakthrough, for a clear correlation with the channel, either ascending or descending. When the price goes above the channel it is in breakup, and when the price goes below, it is in breakdown.
Now let’s look at how channel trading can help us develop sound trading discipline.
Channel Trading Principle 1: Do not trade in the wrong direction
- Do not establish positions in the wrong direction. Do not short in an ascending channel; don’t buy and hold in a descending channel.
- Do not flatten or smooth your position: Do not buy more stocks to reduce your average cost when the price goes up and down and is now forming a descending channel.
- Do not engage in bottom fishing: Do not try to guess the bottom of a descending channel, and buy in when the price is still headed down.
- Do not short the top: Do not try to guess the top of an ascending channel, and short when the price is still headed up.
When you try to establish a long position (buying stock) in an ascending channel, even with traditional stop-loss protection, it won’t prevent you from losing everything.
Channel Trading Principle 2: Stop losses short and let profits run
- Don’t follow artificial stop-loss mechanisms. When you buy a stock, you should have done your homework as discussed in the previous session, and established a position at the channel buy line. If the channel breaks right after you buy in, double check your assumptions and see if there are any new developments. If nothing seems to be wrong, hold till the stock breaks the breakdown line.
- Do not enforce a take profit point. Just follow channel trading principles and hold until it breaks. Any artificial take profit point will entice you to sell prematurely.
Channel trading is a form of dynamic stop-loss protection, it saves you from suffering stop loss remorse. In a conventional stop-loss mechanism, people tend to act based on two approaches.
One: stick to the original stop loss. In this case, you hold on to the stock long after the channel breaks, and by the time the price reaches the original stop loss, it is often too painful to sell. Even worse, many people will hold it till it becomes a real loser.
Two: more diligent investors will manually adjust the stop loss point according to the price movement. Often, they cannot keep up with it, and eventually give up. A worse consequence in doing a dynamic manual adjustment is that you pay too much attention to the rise and fall of the stock; this behavior can affect your judgment.
Even though we do not suggest using static stop loss and taking profit, the system still offers this function for stocks you already own and for calculating risk levels.
OK, now we are ready to use the system to help us execute channel trading.
Good luck in your investments and trading!
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