A security’s price never moves up and down in a straight line.
This movement – known to traders as “price action” – always occurs in waves. It doesn’t matter whether we’re talking about a stock, a commodity, or a currency.
The study of historical price action on charts is one of the chief tenets of technical analysis. And today I’m going to introduce you to an easy and powerful technical tool that can help you spot price action trends and bag profits.
Three Ways to Play
In the financial markets, a stock moves in one of three directions: up, down, or sideways.
An “up” trend is defined as a series of higher highs and higher lows. A “down” trend is a series of lower highs and lower lows. A sideways trend is the temporary lack of a trend in either direction.
As a stock moves in an uptrend or a downtrend, it “retraces” in the opposite direction. Oftentimes, this wavy motion is contained between two bounds.
Technical traders chart this back and forth action in what’s called a “trend channel.” Many online trading platforms offer this tool to investors at little or no charge.
The chart below shows what an “uptrend” channel looks like:
And the chart below shows what a “downtrend” channel looks like:
As you can see, these channels are very effective at highlighting where momentum is going to shift.
Trend channels are also especially useful for locating reversals. When a stock breaks out of an uptrending channel to the downside, many traders view this as a bearish sign.
Likewise, when a stock breaks out of a downtrending channel to the upside, it’s typically a bullish sign.
And the more often the price bounces off the trend channel bounds, the stronger and more trustworthy the channel becomes.
Let’s take a look at how this works on a live example.
Fire Down Below
Five Below Inc. (FIVE) is an American specialty retailer. Founded in 2002, the company operates more than 430 stores in the Eastern United States.
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