Price, like people, never wants to be stuck in the middle of a channel. It prefers to reach the shore despite the fact that is never allowed to touch dry land. Channels in forex are like the impenetrable coastlines of two right-wing nations, they force price to limbo between them until desperation compels a breakthrough of the resistance. Aptly, the Australian dollar is currently providing an excellent example of a downward channel with price bouncing between two definitive diagonal lines of resistance. This has just completed its fourth bounce against the channel walls and is looking ominously for a further decline to the lower support line.
Channels, once observed, can form good trading opportunities as they show clearly where price will ‘bounce’ between the edges of the channel. Traders can wait for reversal signals and affirmative trading patterns to enter with a high probability that the edges of the channel will provide enough resistance and reverse price back down to the opposite side of the channel. These can occur on any timeframe and often the most reliable channel formations can be seen on the higher timeframes such as the daily or weekly. The fundamental correction that the AUD is experiencing also supports its move lower within its current daily channel and this is further supported by its weakness is rally against Mondays sell-off at the channel edge.
Trading channels can occur across any timeframe and can be observed on all stocks, currencies and commodities. The general rule is that the longer a price trades within a range the more dramatic the price movement will be when it eventually exits the channel. Therefore, higher timeframes offer the possibility to trade channel breakouts which are more reliable than those found on lower timeframes. These breakouts can be seen on all forms of channel, where price has continued within this pattern for a substantial period of time and then pushes beyond one of the outer edges of the channel. The probability that the AUD will breakout upwards against the USD is lower than its continuation down to retest its lower channel edge.
Due to the fundamental situation, and the medium term outlook against the overvalued AUD, it may be worth waiting to see if price will form a definite breakout. This is opposed to getting caught in a ‘false breakout’ situation where price escapes the outer edge only to fall back into its familiar channel pattern. The most effective way to trade these breakouts is to wait for the price to break the channel edge and then pull back to the outside of the channel to see if this offers significant support. This is known as a re-test and it occurs very frequently. Price will either fall back into the channel or it will bounce of the outside edge, which will have formed support, and move swiftly away from the channel.
The fact that the AUD USD looks fairly set in a long term downward channel does not disregard the possibility that it may rally if positive news, especially from the Eurozone, comes forth over the next few days. Many traders, however, will be looking for a move lower in contention with the existing channel and the retest of a lower break below the lower channel edge.
