Constructing price channels from trendlines

Identify the directional move

Technical study treats current prices as related to earlier prices. It uses the symmetry of past price moves to form projections rather than fitting an econometric model of market activity.

An advance is identified by a sequence of higher highs together with higher lows. A decline is identified by a sequence of lower highs together with lower lows.

Lock the trendline first

A trendline is a line fitted to the current directional move, usually along rising lows in an advance or falling highs in a decline.

A rising trendline is drawn through successively higher lows and is expected to act as support. Support is a price area, often along that rising line, where selling pressure eases and prices tend to rebound. An economic reading of the same rising trendline is a supply-line: shrinking supply helps lift prices.

A falling trendline is drawn through successively lower highs and is expected to act as resistance. Resistance is a price area, often along that falling line, where buying interest fades and prices tend to stall or turn lower. An economic reading of the same falling trendline is a demand-line: inadequate demand presses prices lower.

A trendline is judged stronger when it has been in place longer and when price has halted at it more often.

Choose one containing boundary

After a trendline is in place, a price channel may be drawn as a pair of chart boundaries expected to contain prices for the life of the trend.

The containing boundary may be a parallel through a significant opposite extreme, a rounded boundary through that extreme, or a line joining significant highs in an advance or significant lows in a decline.

The same trendline and channel constructions can be applied to bar charts and to line charts of closing prices, including versions that connect closes only.

Write the tests that would falsify the channel

A breakout is a move through the trendline and out of the channel. That move can serve as an early indication that the prevailing trend is changing.

A channel penetration is treated as more valid when the closing price, rather than only the session high or low, crosses the boundary. One conventional threshold for accepting a close beyond a trendline is a penetration equal to 3% of the current market price, with expanded volume on the penetration day treated as further confirmation.

Editorial: write the close, depth, and volume checks when the channel is drawn, so a later penetration can falsify the construction instead of being explained after the fact.