Channel Trading Rule

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What Is A Channel?

In stock trading terminology, a channel is the area of price movement that occurs between two lines. Our NOTB chart uses a channel formed at the top by the highest price of the day and at the bottom by the lowest point of the day. This is the range of price movement for the day. A series of days are plotted to show movement relative to the Blue line. Many other types of channels are used by stock analysts. A common example would be a regression channel formed by plotting a fixed distance on either side of a linear regression line of the stock's price over time.

What Does Channel Charting Do For You?

A channel offers five distinct advantages over the traditional method of plotting a single line of the day's closing price:

• First of all, observe the relationship of the prices to each other. A high price line will eventually bottom out and begin to rise. Note that when the low price line rises above the lowest point of the high price line an upward shift is indicated (See May, July, November above).
  Conversely, a high price line will eventually top out and start to fall. When the high price line falls below the highest point reached by the low price line, a downward shift is indicated (See August, October, December above).

• Second, early warning signals are always provided. The high price line rising up through the blue line provides an early buy signal. The low price line falling through the blue line provides an early sell signal. Advantageously, you will still have time to sell above the blue line and buy below the blue line. This is not possible using a single line method.

• Third, channel trading solves most of the problems associated with multiple red windows for sharply declining stocks. An example is Hovnanian (HOV), whose stock price lost 40% of its value between August and November of 2005. Three red windows occurred before the price bottomed. Using our NOTB channel trading method would have limited your exposure to a short window in September, 2005. By November, 2005, if you were still unconcerned about the home building sector, you could have made a little money before the end of 2005.

• Fourth, there is a predictable relationship between the Moving Average (MVA) blue line in the top chart and the High Price Strength (HPS) blue line in the middle chart. Notice that 99.9% of the time, when the MVA line flattens and turns up (May, July, November above), it will coincide with a movement of the HPS line to above 50. It is important that the momentum continues above 50 (See early October above). The reverse is also true that the MVA line will top out and turn downward (June, August, September, December above) to coincide with the HPS line falling down to below 50. These are powerful confirmatory indicators for trading.

• Fifth, there is a definite and observable change in the volume chart at the bottom of the screen that coincides with changes in the slope of the MVA line. When the MVA line flattens and then turns up, you will see 3-5 days of consecutive blue volume bars on the bottom chart. This will occur at the point of slope change and actually causes the upward change in slope (see May, July, November above). Notice how August (above) did not have this pattern and failed quickly. The reverse is also true with a concentration of red volume bars occurring during the break down of an MVA slope.

Using The Channel Trading Method

In simplist possible terms, watch the low price line. Buy when it crosses above the MVA line and sell when it falls below the MVA line. Taking the time to use the supporting conformational indicators will improve your timing and profits.

In a separate article (Bob's Blog I on the NOTB website), I began following the Semiconductor ETF (SMH) in May of 2005. I narrated my trading experiences for SMH as I bought the stock in May and again in late October, 2005. Both trades were nicely profitable, but I missed the July-August run up. In this article I wanted to show what could have been done with this stock using the channel trading method.

Using a buy and hold strategy you would have bought SMH on Jan 3, 2005 at $32.49 and sold it on Dec 30, 2005 at $36.64. Your return for the full twelve months invested would have been 12.77%. Not bad at all!

Using our NOTB Channel Trading strategy you would have bought and sold the stock six times during the year:

• Buy Jan 26 at $30.75 and sell Mar 14 at $33.35. Profit of 8.78% for 7 weeks invested.
• Buy May 2 at $30.80 and sell Jun 15 at $34.13. Profit of 10.81% for 6 weeks invested.
• Buy Jul 6 at $34.41 and sell Aug 4 at $37.06. Profit of 7.70% for 4 weeks invested.
• Buy Sep 6 at $36.93 and sell Sep 19 at $36.47. Loss of -1.25% for 2 weeks invested.
• Buy Sep 30 at $36.87 and sell Oct 4 at $36.44. Loss of -1.17% for 1 week invested.
• Buy Nov 3 at $35.08 and sell Dec 8 at $37.41. Profit of 6.67% for 5 weeks invested.

Your total return would have been 31.47% for 25 weeks invested. That is 62.94% annualized. These numbers speak for themselves!