Simple Channel Trading System

A simple channel trading system can be set up using two moving averages. A five period simple moving average of bar highs and five period simple moving average of bar lows.

If you prefer, other types of moving averages can be used to form the upper and lower channels, such as an exponential, weighted or hull ma's.

This channel trading strategy can be used on any time frame. The shorter the time frame you trade on, the more trades you'll have. But, of course the profit you'll be looking for will be smaller too.

With this method, you are basically waiting for a trend to develop and then a pullback to occur for an entry. The channel is both a trend finding tool and a timing tool.

While this strategy is no holy grail it does have a knack for putting you into some nice pullback trades. Just watch out for ones that pullback like they're supposed to, but keep on going once you've entered!

Here's the simple channel trading system:

COMPONENTS

5 min Chart

5 SMA of price Highs

5 SMA of price Lows

SIMPLE CHANNEL TRADING SYSTEM SIGNALS

As mentioned, the channel is both a trend finding tool AND a timing tool. How do you know when using this strategy that price is in a trend?

When three consecutive bars close outside of the channel you have a trend and a setup. In the case of an uptrend, you'll need to observe three consecutive closes above the upper channel line.

The entry trigger occurs if and when price pulls back to the lower channel (or at least very close to it). You'll find that in the case of an uptrend, the lower channel will often act as resistance. Once in, you are then looking to exit at the upper channel, or if price action and volume is really strong, possibly hold on for more.


Buy Setup: Three consecutive bar closes above upper channel line.

Buy Trigger: Price pulls back and touches lower channel line (or very close).

Exit: When price reaches opposite upper channel line or above if there is strong momentum.


Short Setup: Three consecutive bar closes below lower channel line.

Short Trigger: Price pulls back and touches upper channel line (or very close).

Exit: When price reaches opposite lower channel line or below if there is strong momentum.


I'd like to emphasize several things about the simple channel trading system, before you try to use it:

  • This day trading strategy requires a trader be very alert and eyeing the screen constantly in order to catch entries. As opposed to most of my day trading strategies that allow you place buy stop orders and not be glued to the screen, since the orders are preset.
  • If you get an entry trigger, which is based on a pullback to the lower/upper channel line and not a breakout of the high/low of any candle, you must be very aware of the fact that price can keep moving in the direction of that momentum very quickly. And, since there is often no good place to quickly place a support or resistance stop, you might consider applying an automatic point or percentage stop upon entry.
  • This type of scalping strategy usually requires taking small profits, since the point distance from channel to channel is generally small on a lower time frame chart. In order to be successful with this method, you'd have to keep losses very small, and again this requires that you be very alert. You'd also have to have probably more than 60% winners to make this work, since most of the winners will be small. If you don't understand why, please review the page on stock market trading expectancy.
  • Be aware that when using fast moving averages in real-time like a 5 sma, and especially exponential or weighted moving averages, that the end point of the ma line will actually have a bit of movement. Since the closing price of the current bar is constantly changing in real-time, that will cause the calculation of the ma to change in real-time as well. So, as the bar is heading towards the line, price will 'push' away slightly, and even more so with a weighted moving average
  • When using the simple channel trading system, since it requires relatively quick entries and exits, I highly suggest using it only on very liquid stocks or ETF's such as QQQQ or SPY

EXAMPLE


simple channel trading system on chart of QQQQ