Simple Mini-Channel Breakout Strategy – Get Into Trending Moves Early

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Trading the “Mini-Channel Breakout”

Watch a trend develop and you will see pullbacks along the way—brief counter-trend moves that quickly disappear as the trend re-emerges. Entering on these pullbacks can be lucrative, but most traders go about it the wrong way. They either enter too early when the pullback is still occurring–and then have to hope the pullback soon reverses–or they wait till the trend has clearly re-established itself, but by then much of the move may already be over. The following strategy attempts to solve these issues. While it won’t win every time, this simply mini-channel breakout strategy will help you get into trending moves early, but with a level of safety, since the breakout will signal the pullback has likely ended and the trend direction is re-emerging.

A trend is not a relentless move in one direction; rather it’s a series of strong impulse waves in one direction separated by pauses or smaller reversals (corrections) in the opposite direction. Therefore a trend is composed of both impulse waves and corrections. No matter which time frame you trade on, generally you will see the market move in 3, 5, 7… wave patterns. A 3 wave pattern consists of an impulse, a correction, followed by another impulse. A 5 wave pattern is an impulse, correction, impulse, correction then an impulse. Tack on another correction and impulse for the 7 wave pattern. To some this may sound like Elliott Wave Analysis, it is not. No experience or knowledge of Elliott Wave analysis is needed to use this strategy, and no “wave counting” is required.

Look at a chart and with a bit of practice you will see every trend takes this configuration (figures below). Not rocket science, but upon this little insight you can base a powerful strategy. Each correction—which often appears to look like a mini-price channel–provides a potential entry signal to get into the next impulse wave of the trend. Such entries provide relatively low risk, profit potential and a plethora of trade signals each day, especially if you trade multiple forex binary options pairs or assets.

Mini-Channel Breakouts

Figure 1 shows the EUR/USD from the open of the US session. From just after 8:00 till 10:00 a 5 wave pattern developed. I have highlighted it in black for demonstration purposes. The labeling with the numbers is not important, but is simply used to show how trends develop in impulse, correction, impulse… patterns.

Figure 1. EUR/USD 5 Minute Chart – March 11, 2020

So how does this help us? Since we know that most of time a correction is followed by a move back in the trending direction, we can look for corrections. As the correction is forming—bars start to move counter the former direction, such as in waves 2 and 4 above—we draw lines along the highs and lows of the correction to create a mini-channel (see figure 2).

As the day continued on March 11 an uptrend developed (multiple waves), interspersed with minor corrections. I have marked some of these corrections on Figure 2 in black.

Figure 2. EUR/USD 5 Minute Chart – Trend with Mini-Channels

By drawing the mini-channels on the chart, we provide ourselves with a potential entry signal. In Figure 2, we have strong moves higher, followed by moves lower (mini-channels). When the price breaks back above the mini-channel a long/buy/call trade is taken. In a downtrend we have strong moves lower, followed by corrections (mini-channels) higher. A short/sell/put trade is taken when the price breaks below the mini-channel.

Unfortunately, not every breakout results in a sharp move in the direction of the former trend, and it is very possible to get false breakouts since the channels are small and we must draw them in real-time.

Drawing the channels can also be somewhat subjective. Comparing charts with another trader at the end of the day, it is unlikely all the mini-channels would be marked the same. Also, corrections may not always take the form of well-defined channels; corrections may be erratic, and not easily contained between lines.

Stops and Profit Targets

If trading binary options, you don’t need to worry about stops or profits targets. Rather simply make sure that the time frame you are watching corresponds to the time frame of the option you trading. For example, a breakout on a one minute or five minute may not do you any good if your option doesn’t expire for several hours. If your trades last hours, use a 15 minute chart. If your trades last minutes, use a one or five minute chart—or both.

The strategy for entries is simple—look for a strong move in one direction (impulse), wait for a pullback, draw a channel around it, then wait for the breakout to occur in the direction of the impulse. Getting in is only part of the battle though for those not trading binary options; you also need to control risk and plan for a profitable exit.

To control risk, place a stop just below the most recent swing low, prior to the breakout. Your risk is the difference between the entry price and your stop price. Set your profit target at 2 to 3 times your risk. For example, in an uptrend if you risk is 15 pips, place a profit target at 30 to 45 pips above your entry price. I personally set my profit target at 2X my stop. Figure 3 shows an example from the morning of March 11. The trade had a 5 pip risk, and therefore a profit target was placed 15 pips above the entry price.

Figure 3. EUR/USD 5 Minute Chart with Entry, Stop and Profit Target

This strategy provides many signals, and as trends end and new ones begin this is where losses typically occur. After some practice, attempt to filter out some of the signals using indicators or wave counts to avoid being on the wrong side of the market when a change in trend direction is likely.

Final Word

Markets move in a continual pattern of impulse, correction, impulse, and so on. Even when the overall price movement is confined to a range, you will typically still be able to see this type of movement. Yet, this type of strategy is best utilized when an asset is active and moving freely, and not confined to a range. When trends reverse, the impulse, correction, impulse patterns begins in the new direction. While the strategy appears quite simple in theory, in the real world it is more difficult to implement since you must constantly be determining the direction of the trend, and whether a correction is actually the start of the new trend. Use a demo account to practise isolating impulse and correction moves. Draw the mini-channel lines on the corrections and attempt to profit from the impulse waves that follow. While intra-day examples were used in this article, the technique can be applied to any time-frame.

Mini Channel Breakout Forex Strategy

Video Transcription:

Hey, Traders. Welcome to video three of the Advanced Forex Strategies course. This is Cory Mitchell. In this video, we are looking at mini channel breakouts. This is a strategy we can use on all timeframes. This video is brought to you by Investoo.com.

So, a little review from the last video. Trend trading is where most of the money is. There are multiple ways to trade trends, but this is one that you want to have in your arsenal. It gets us in early, keeps risk small, and profits are larger than losses. It can be used on all timeframes, for day trading or swing trading.

So, an uptrend occurs when the price is making higher swing highs and higher swing lows. This should sound familiar if you watched the last video. If not, we will go through this concept of trends again in this video. Downtrends occur when the price is making lower swing lows and lower swing highs. We only trade in the direction of the trend with these strategies.

This is a relatively simple setup, but it doesn’t occur as often as we’d initially suspect. But when there is a very strong trend, it will occur frequently, and that’s mostly when we want to trade because it provides us a lot of opportunities to get in on that trend and make money. We’ll look at other trend trading strategies as well, so that no matter what the trend looks like, you have a way to trade it.

So, during an uptrend, we’re waiting for the price to pull back. We avoid trades when the trend on our timeframe isn’t clearly visible. A line must be able to connect the high point of at least four bars in the pullback. When this occurs, typically the pullback has a channel-like appearance. Sometimes, it’s not beautiful, but we at least need those four high points in the bar to pull back to be able to connect. This allows us to draw a line and a breakout point.

If it doesn’t sound clear, in a moment it will, when we look at a few examples. We buy when the price breaks above that channel in the trending direction, back in the trending direction. We’re looking for a certain look, a counter-trend move, where the breakout is clearly visible.

Once we’ve drawn that channel, our stop goes one pip below the low of the channel, following the breakout price. Once the price is broken out, sorry. We’ll place that stop one pip below the channel low. Our target, similar to the last video, we’re using the 1.6 and 2.6 times risk. So, if we have 10 pips of risk, we’re looking for our first target at 16 pips and another one at 26 pips. We do this by taking two positions instead of just one larger one. If you can afford to take two mini lots, take two positions of one mini lot each, so that you can get one out at each target.

During a downtrend, we wait for the price to pull back. We avoid trades when the trend isn’t clearly visible. A line must be able to connect the low point, in this case, of four bars on that pullback. So, we sell when the price breaks below that line. So, it will be moving back in the trending direction, and we want to get in on that.

The stop goes one pip above the . . . Sorry. That should say high, one pip above the high of the channel, because the price will be coming down. The channel will be going up. So, we want to put the stop one pip above the high of the channel. Our target is 1.6 and 2.6 times our risk.

Once again, if we can take two positions instead of one larger one, we will do that. Keep in mind from the last two videos, we want to keep risk to 1% of our trading account per trade. So, if we have a $500 account, we’re only risking $5. Pretty tough to do. But if we have a $3000 account, we’re risking $30 per trade. So, keep that in mind.

So, let’s look at a few examples. I’ve highlighted a few in the Euro/USD. A couple weeks back, we had some pretty good action going. We had the Euro flying higher, and then a big reversal back to the downside. So, this is what we talked about. When we have very strong movement, we’re going to see lots of these little mini channels.

So, here, strong move higher, proceeding from a longer term uptrend. So, you’re looking for it. Notice here, I’ve set . . . This is only three bars. So, technically this isn’t a valid setup. We want four, but we are on an hourly chart. You could drop down to a 30-minute chart. And how many bars would that be? We have three bars here on the hourly chart. That means you’d have six bars. If you get four that line up, you have a valid signal.

So, you can . . . It’s not cheating. You just drop to a different timeframe for certain setups if you see it and you want in. But basically, we’re looking for four points, just so that we know that we have a solid resistance level there. When it breaks, we know we’re [inaudible 00:05:08]. So, this one would have been a great trade here. As soon as it broke, it flew to the upside.

Here, pause again, not really . . . Can’t really draw a channel around this. We sort of could, but here we have the lows that connect. The ones on the bottom don’t really matter too much. You can put them on if you want, but we know from strategy that we’re going to be putting our stop one pip below. So, we don’t really need the channel.

So, we are going to be entering here as soon as it breaks out. We do not wait for bars to complete. As we can see, if we would have waited for this bar to complete, the price would have been way up here. As soon as it breaks that line, we get in. So, our entry point is right around here, looking at about 13.8 pips of risk here. We take targets at 1.6 and 2.6 times our risk, 13.8 times 1.6. So, our first target would be at 22.08 pips or 22.1 pips.

Then, this one is 13.8 times 2.6. So, this one would be at 35.9 pips. If you notice from the last video and from this one, typically the 1.6 target will be very near the former high. It just seems to work out that way. It will be in a close proximity to the former high. That way, if the price fails to go higher and makes a double-top type formation and then proceeds lower from here, we at least got that one target out near the former high. Because once this pops, there’s a pretty good chance that it’s going to at least go back and test this former high here.

So, we had the pop higher. It’s testing it. In this case, it worked out well. It continues to go higher. While we were in this trade, you could have had another opportunity here. One, two, three, four. We have four bars that form a little channel type here. This is one of the ugly ones I talked about. If we were to draw a line, it doesn’t really have a channel-like appearance, but this line does. That’s the one we’re looking for. We have a clearly defined level that we can watch for a breakout above. When it does, we’ll watch for the pop higher.

These are a little bit subjective. You have to be in there in real time, and you have to be able to say, all right… We had this nice strong pop higher. I do have this level. Do I want to trade it if it breaks out? Same with here. Same with here. So, we had this pop higher, a pullback. Do I want to trade this if it breaks out?

This would have been a very aggressive trade after the strong uptrend, but it is a valid signal because we have a lower low. We’ve had a number of little movements here, and the price drops below them. Then, on the rally higher, we are making a lower high. So, this is a decision you have to make in real time. Once you draw this line, the price is moving up if we go out to the very right-hand side of the chart, like this was happening in real time.

The price is creeping up. We’ve had this strong run-up. What do we want to do? We have to decide. All right. If this breaks below this line, am I going to take the short? You say it’s going to cost me nine pips of risk. Once this breakout occurs, yes, I’m going to take that trade. So, we take it. We’re looking at about nine pips of risk because we’re putting our stop one pip above the former high of the channel.

So, this was the high of the channel. This one we actually could have drawn because it does actually have a channel-like appearance. So, here’s the high of the channel. Here’s our entry point. We’re looking at about nine pips of risk if our stop goes right here.

This one would have worked out quite well going into the weekend, if we had held it over the weekend. Our initial target, 1.6 times 9, is 14.4 pips. We didn’t quite get there before Friday. So, if you have a nice broker, the next morning you would have made 35 pips instead, or on Monday morning, Sunday night.

Same with the next one, 9 pips times 2.6, which is our next target, 23.4 would have also got filled at the following open, if you have a nice broker. Some brokers may just pocket that difference. But 9 pips of risk, entry point right here on the breakout.

Here, we have one that would have worked out. We have this nice run to the downside, have the gap on Sunday, channeling higher, well-defined area here where we were looking to go short. We would have gone short right in here when the price dropped below. Stop would have been placed right about there. So, we have this nice channel-like appearance, but we would have been stopped out on it.

Just moves above our stop, and then proceeds to go in the direction we expect. This is Forex trading. We cannot avoid these trades. I don’t even try to avoid these trades because we know that they will inevitably occur. When we learn a strategy, we’re expecting that it will work about six or seven times out of ten, hopefully at least four or five times out of ten. That way, we’re making 60%, at least 60% more on our winners. So, even if we win 50-40% of the time, we still should be coming out ahead. Therefore, we do not need to try to avoid these. This is going to happen. Do not be frustrated by it. Just look for another opportunity.

So, a little review. Every trade has a stop and a target. Put these targets out when you place the trade. Only risk 1% of your account in any one pair. That includes your taking multiple positions instead of one larger position, but you’re still limited to that 1%. That way, even a string of losses won’t significantly draw down your account.

Only trade in the trending direction, following a pullback. That pullback must have a channel-like appearance. Remember, it can be ugly, but you at least need to have that clearly defined breakout point. If it’s not a clearly defined breakout point, don’t take the trade.

Place a stop above the high of the channel for a downtrend. Place the stop below the low of the channel for an uptrend. When possible, keep risk below 1%, split up your positions, and take profit at two targets. These targets are 1.6 and 2.6 times your risk. Trading involves substantial risk of loss. Only trade with capital you can afford to lose. Trading with capital that you absolutely need will result in an outcome that you do not like.

Test out strategies before using them to make sure you’re actually able to implement them and that they work for you. Use a demo account. Trade this. Work on it. Do it in real times that you can actually see these channels forming. Trade the breakout. Set your stops. Set your targets. You can get good at it before actually using real money. Until next time, happy trading.

More About Adam

Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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