Further Talk on Micro Channels

Breakouts from micro channels may suggest different scenarios

Similar to traditional channels, micro channels can be considered as sloping trading ranges, thus, a magnetic pull seems to obstruct prices, not allowing them to break out at a significant distance from these ranges.

If a breakout from a micro channel occurs, it usually lasts for 1-2 bars, with the reason behind it being locking in gains. Let us have a bull micro channel. Eventually a bar forms below the low price of the preceding bar, which leads to a breakout from the channel to the downside. There probably were sellers entering into short trades there, but the main reason behind this breakout was buyers, taking their profits. After the next 1-2 bars other buyers entered the market, while some sellers left, which causes the following bar to close above the high price of the prior bar. This can be viewed as a fakeout from the channel, so some traders will look to go long as the price moves above the high of the previous bar. Other traders may expect a reversal in the underlying trend.

The context is what may provide a hint which scenario is to develop. First, in case the underlying trend is a strong downtrend and the bull micro channel is nothing more than a pullback, there is a chance that the breakout below the micro channel may be followed by additional shorting. If prices move above the breakout bar, bears are likely to place a stop order to sell below the low price of the previous bar.

And second, in case the bull micro channel appears simply as a breakout from a trading range in a strong uptrend, the breakout from this channel to the downside may be just a pullback in the underlying uptrend. Bulls are likely to place an order to buy a few pips above the high price of the prior bar.

A breakout from the trend line of a micro channel may serve as a signal to enter in the direction of the trend. Let us have a bull micro channel formed in an always-in long market. If a bar appears, which has a low price below the trend line of the micro channel, some traders may go long at the high price of that bar. This may be interpreted as a one-bar bull flag and as a failed breakout to the downside, thus, indicating a buy opportunity.

A bull micro channel may appear in a trading range or in a downtrend. In this case a trader should take into account something else before deciding to go long above the failed downside breakout. If the channel is formed in the upper area of a trading range, a more appropriate decision is not to buy the downside fakeout, but to wait and see whether the reversal to the upside will stagnate. If this reversal up lasts for only 1-2 bars and then a bear reversal bar appears, it provides the trader with a selling opportunity (especially if this situation occurs close to the peak of the trading range).

A bull micro channel may be breached to the upside (or above the trend channel line), which implies the market is attempting to begin an even sharper uptrend. However, if this attempt is a failure and a large bear reversal bar appears, it is simply a buy climax, thus, traders should look to go short.

If a micro trend line is drawn across ten or more bars, the probability of a tradable reversal to occur increases significantly. Such a trend may not last long (it is more like some type of a climax). Therefore, it is logical to expect a pullback or a reversal. One should look for an entry on the breakout pullback, following the climax.

The importance of micro trend lines

A break of a micro trend line is crucial not only when this line represents an element of a micro channel, but also when a strong trend is yet to develop. If a trader identifies a strong downtrend with huge bear trend bars, little or no overlap between successive bars and no pullback bars forming for a while, he/she will be very anxious to go short. In this case the trader should search for any bear micro trend line and go short below the low price of any bar, breaching this bear micro trend line. Every breach may be a failed breakout, thus, an opportunity to enter into a short position. The entry may be a few pips below the bar, that breaches the bear micro trend line.

Short and steep trend lines (drawn across two successive bars) provide an opportunity to enter in the direction of the trend. If the underlying trend is steep, a small pullback bar may breach a short micro trend line. This bar may become a signal bar to enter in the direction of the trend.

In a pullback during a trend a micro trend line is commonly observed. In a pullback during an uptrend, if one detects a micro downtrend, that continues for two to ten bars, and a breach of the bear micro trend line is present, such a situation may suggest a failed breakout (respectively a short entry). However, this happens during a bull trend (and often close to the exponential moving average), so it is not appropriate to take such a trade. One may appear to be in a short position at the low of a bull flag and close to a rising moving average (obviously the chances for a successful trade are very low).

Cunning price action traders will be waiting to buy this failure. They will go long exactly where the trapped sellers exited the market. Their long positions will be a breakout pullback buy, as the price breached above the bear micro trend line, pulled back and continued again in the direction of the breakout (also the direction of the underlying trend during the trading day).