Recently, we made a case for adding a few technical tools to your belt. As we put it, using a couple of trusted patterns or indicators can prove useful — even if you don’t consider yourself a “trader” or otherwise technically inclined.

As it so happens, one simple pattern can help you easily book winning trades in a trending market.

The pattern is called a trend channel.

You don’t have to be a professional trader to take advantage of this setup. You can even use the pattern we’re about to show you if you know next to nothing about technical analysis. All you have to do is recognize the key features and respond to the pattern’s clear buy and sell signals.

What Is A Trend Channel?

A trend channel is easy to spot. It consists of a trending stock flanked on either side with a high and low range.

This is used to identify the direction and range of a trend by drawing two parallel trend lines diagonally on a chart to connect a series of highs (an ascending channel) or lows (descending channel). The channel defines the upper and lower boundaries of a trend and can help traders identify potential levels of support and resistance.

A channel can also indicate whether a trend is strengthening or weakening. A narrowing channel can indicate that the trend is losing strength and that a reversal is imminent. A widening channel, on the other hand, can indicate that the trend is gaining strength and that a continuation is likely.

Let’s take a look at an example, courtesy of Nvidia (Nasdaq: NVDA) in 2020. Following the Covid selloff, the high range (resistance) is marked by a blue line. The low range (support) is marked by the red line:

Buying channeling stocks makes good sense in a bull market. The important ingredients are usually in place to execute a successful channel trade.

First, the market is trending higher. It’s always in your best interest to take the path of least resistance when trading. So if you’re planning to go long, you want the overall trend moving in your favor. Since stocks generally move higher in a bull market, trading a rising channel will sync your buying with the broad market.

Next, a pullback could expand your trading options. The best time to buy a channeling stock is when it bounces off the lower end of its trading range (the blue line in our example). As the market retreats from overbought levels, many channeling stocks follow suit. With more prices testing channel support, you have a variety of channeling names that are flashing buy signals.

How Traders Use It

Buying a stock as it bounces off support is an ideal low-risk trade. If support fails to hold, you can exit the trade with minimal damage to your account.

Finally, a stock trending higher in a channel could be setting up for an even bigger move. A stock that is exhibiting a channel pattern is already trending higher. But if the stock breaks above resistance (the red line in our example), the uptrend could accelerate. Old resistance becomes new support, and the stock moves even higher. Using the channel, you should be able to time your buy to maximize gains.

One of the main benefits of channeling stocks is that they give you clear-cut buy and sell signals. Channels are also useful for traders with different goals. For example, take a look at the buy and sell points noted with the arrows on our next chart.

If you’re a trader who is comfortable using shorter time frames, you can use the channel to make multiple trades. You can buy at support (blue arrow) and sell at resistance (red arrows), taking profits along the way. Or, if you prefer to hold positions for a longer time frame, you can act on the initial buy signal and hold the stock for the duration of the trend.

In this example, assuming you didn’t have the foresight to get in at the bottom, a buy signal on NVDA at around $90 would have led to significant profits before the channel was breached at around $125. Of course, you would have left some profits on the table, but this is an example of a significant, easy short-term gain from such a simple pattern.

Action To Take

You don’t need any fancy pattern recognition software to find the perfect channel trade. You can go to virtually any free online stock screener or charting tool to search for trade candidates. It can be as simple as searching for stocks within 5% of their 50-day or 52-week high. Or, you could search for stocks that are trading above their short, medium, and long-term moving averages.

The key is finding stocks that are trending higher. Then, it’s just a matter of scanning the charts and finding the best-looking channel setups. No matter how you search, you should have no problems finding low-risk, high-reward channel trades.

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