Trading in financial markets can be a challenging task, but with the right tools and techniques, it can also be an incredibly rewarding experience. One of the indicators that can help a trader build a reliable strategy is the ascending channel pattern. In this FXOpen guide, we will discuss what ascending channels are, how to trade them, and provide clear examples of doing so.
What Is an Ascending Channel Pattern?
Channels are a common occurrence on price charts. They represent a period of consolidation when the price ranges between parallel support and resistance levels. There are three types of channel patterns: ascending, descending, and rectangular.
The ascending channel is different from the plain rectangle formation in the way that it slopes to the upside, while a rectangle is a horizontal range. At the same time, it differs from the descending pattern in that the falling channel slopes to the downside.
Also known as a rising channel pattern or an upward channel pattern, this bullish formation can be found primarily in the uptrend. It is characterised by two parallel lines. As the price of an asset moves higher over time, these two lines are formed by connecting higher highs and lows, creating boundaries that the price interacts with.
It marks a period of consolidation after which a breakout in either direction may occur so that the price may continue moving in an uptrend or reverse down. In some cases, we can see it in a downtrend, where the price can also break out in any direction. So the ascending channel pattern can be both bullish or bearish but is primarily bullish, as even in a downtrend, it can provide an early sign of a reversal.
How to Construct an Ascending Channel Pattern
To construct the formation, traders need to identify at least two highs and two lows. Traders typically connect these two points with a trend line, which is then used as the basis for the channel pattern. The first line is drawn by connecting higher highs, while the second line is drawn by connecting higher lows. The channel is in place as long as the price remains within it and continues moving higher over time.
Now let's look at some live charts on our charting platform TickTrader and see if we can construct some examples of this formation.
The EURUSD 5-minute chart shows that after an impulsive move to the upside, the price started consolidating before the uptrend continued. This brief pause in the trend is the rising channel.
It can be drawn out manually with the use of a trendline tool; however, it may be a better way to utilise the “Parallel Channel” tool that also shows the median line of the range. This can be useful in trading according to the mean reversion strategy.
As it was stated, it can also be a bearish pattern, indicating further downtrend continuation after it completes. It’s reflected on the EURUSD 5-minute chart above.
How to Trade an Ascending Channel Pattern
There are two main approaches when it comes to trading this formation.
The first one is the mean reversion strategy which involves trading the range itself. The second one is waiting for a breakout and catching a trend continuation or reversal.
In the case of mean reversion, a trader can either buy at support or sell at resistance, anticipating that the price is going to reverse at least to its median line of the range. If a breakout is anticipated, the target can be beyond the range, but the 2nd target is always on the next level from the median line.
The entry in this example was on the support level since we have seen a third interaction with it, resulting in a bounce. A stop loss is placed below the last low because if it goes below it, the scenario would be invalidated. The first target is at the median line because there is still a possibility that a breakout to the downside might start after a potential rejection occurs. However, risk management can be done by raising the take-profit order and trailing it closer to the resistance level.
This strategy is mostly used in scalping but can be implemented in various approaches, depending on the timeframe. Since the markets range quite often, it is beneficial to understand how to stay active in these periods with this strategy.
A more popular technique is the ascending channel breakout. This involves waiting for the price to break through one of the boundaries. The direction of the breakout can also provide important information about the trend, as a break to the downside may indicate a bearish reversal in an uptrend or a continuation in a downtrend, while a break to the upside may indicate bullish momentum.
Considering that the price was in a range and there could be false breakouts, it is important to wait for a breakout confirmation before entering a trade.
A breakout is confirmed by three points. First, the price needs to surpass the boundary. Second, it needs to retest the boundary. Finally, a trade can be opened on the third confirmation, which comes in the form of a price surpassing the breakout high in an upward movement and the breakout low in a downward movement. Only then can we be sure that a breakout is confirmed and enter a trade with confidence.
A stop-loss level can be placed below the breakout trendline in an upward movement and above the trendline in a downward movement, as if the price returns to the range, a breakout will fail. A take-profit ascending channel pattern target can be calculated by projecting the length of the previous move before the setup formed to the starting point of the impulse that made the breakout.
The ascending channel pattern is an important and versatile technical analysis tool that traders can use to identify trends and make informed trading decisions when trading forex and financial markets in general.
Regardless of the level of experience, an understanding of the ascending channel pattern and how to trade it can help you maximise your returns and minimise risks in the financial markets. In order to safely practise identifying and trading this formation, it is best to start on a demo account.