What Is an Ascending Channel?
An ascending channel is the price action contained between upward sloping parallel lines. Higher highs and higher lows characterize this price pattern. Technical analysts construct an ascending channel by drawing a lower trend line that connects the swing lows, and an upper channel line that joins the swing highs.
The pattern’s opposite counterpart is the descending channel.
- An ascending channel is used in technical analysis to show an uptrend in a security’s price.
- It is formed from two positive sloping trend lines drawn above and below a price series depicting resistance and support levels, respectively.
- Channels are used commonly in technical analysis to confirm trends and identify breakouts and reversals.
Understanding Ascending Channels
Within an ascending channel, price does not always remain entirely contained within the pattern’s parallel lines but instead shows areas of support and resistance that traders can use to set stop-loss orders and profit targets. A breakout above an ascending channel can signal a continuation of the move higher, while a breakdown below an ascending channel can indicate a possible trend change.
Trading the Ascending Channel
- Support and Resistance: Traders could open a long position when a stock's price reaches the ascending channel’s lower trend line and exit the trade when the price nears the upper channel line. A stop-loss order should be placed slightly below the lower trend line to prevent losses if the security’s price abruptly reverses. Traders who use this strategy should ensure there is enough distance between the pattern’s parallel lines to set an adequate risk/reward ratio. For example, if a trader places a $5 stop, the width of the ascending channel should be a minimum of $10 to allow for a 1:2 risk/reward ratio.
- Breakouts: Traders could buy a stock when its price breaks above the upper channel line of an ascending channel. It is prudent to use other technical indicators to confirm the breakout. For example, traders could require that a significant increase in volume accompanies the breakout and that there is no overhead resistance on higher time frame charts.
- Breakdowns: Before traders take a short position when price breaks below the lower channel line of an ascending channel, they should look for other signs that show weakness in the pattern. Price failing to reach the upper trend line frequently is one such warning sign. Traders should also look for negative divergence between a popular indicator, such as the relative strength index (RSI), and price. For instance, if a stock’s price is making higher highs within the ascending channel, but the indicator is making lower highs, this suggests upward momentum is waning.
Ascending Channel vs. Envelope Channels
Envelope channels are typically used to chart and analyze a security’s price movement over a longer period of time, whereas ascending and descending channels can be beneficial for charting a security’s price immediately after a reversal. Trend lines can be based on moving averages or highs and lows over specified intervals.