Pattern Recognition: Channel Breakout

Pattern: Channel Breakout

The Channel Breakout technique is a simple, robust trading method made famous by the Turtles Traders. It’s a profitable pattern favoured by many great traders and money managers.

Like the Moving Average Breakout method, the Channel Breakout attempts to catch the early trend. As a result, whipsaw is a high probability as is a high loss rate but the percentage win/loss ratio is not important as a system that loses the majority of the time can still be profitable when the correct money management is applied. (Money management is covered in Building a Profitable Trading Plan Using Technical Analysis).

We’re not talking about trend channels created with two trend lines or Bollinger Bands. The channels we’re referring to here are simply recent high and low points and the breaking of such points. No trend lines or indicators are needed.

The Setup

The channel is simply a high point or low point within a recent trading period. In trader talk, we refer to these high and low points as ‘the highest high in n days’ and ‘the lowest low in n days’ where ‘n’ refers to the length of the look-back period to determine the high and low points. Like the Moving Average Breakout, the longer the look back period, the less whipsaw, but the greater open profits that can be left on the table.

The basic Turtle parameters were:
Entry: n = 20 days Exit: n = 10 days

So, we look for the highest high in 20 days or the lowest low in 20 days. When exceeded, these two levels become our entry points. We have basically put a boundary on either side of the current market, which is essentially our ‘channel’.

The Entry

The tricky thing with this method is that you’ll have an entry or exit running in any market at any time. With the use of software such as Amibroker you can automate the signals each day.

Once the boundaries of the channel have been established we place a Buy Stop to enter long above the upper boundary or a Sell Stop to enter short below the lower boundary. Place a Buy Stop 1 cent above the upper boundary and a Sell Stop 1 cent below the lower boundary. You will know these levels before the opening of trading the next day and can comfortably set these levels within your online broking platform well in advance.

Long Channel Breakout Entry:

Short Channel Breakout Entry:

If the Channel boundaries are not breached, simply move the Channel along the extra day and adjust your entry boundaries for the next trading session. This will continue until you have entered the market, either long or short.

More information on Channel Breakouts including how to exit and manage the trades is available in Building a Profitable Trading Plan Using Technical Analysis course provided to members of The Chartist within the Education Section.

In our next article we’ll discuss Divergence