Learn how to swing trade stocks using the trend channel strategy, including how and when to enter and exit trades, how to manage risk, find stocks to trade, what indicators to use (if any), and when to avoid trading.
Swing trading is a great way to earn extra income because it can be done at nearly any time day. Even if the market is closed, trades can still be looked for in the evening and orders placed. This is typically how I trade.
The reward potential in swing trading is plentiful, but so are the risks.
Making money consistently requires a few steps.
- Build a trading plan. At minimum, this will include how you enter and exit trades, how you control risk, what stocks you will trade, and guidelines for when and what you shouldn’t trade.
- Practice like crazy, but only practice what is in your plan. NOTHING ELSE!
- Learn to manage and work with emotions, and stick to the plan when real money is on the line.
Two and three are the really hard ones. Most people can come up with a plan or strategy…because in this article I am going to give you one. I will lay out how to enter, exit, risk management, what to trade, and when. It is a solid strategy and is covered in more detail in my Complete Method Stock Swing Trading Course.
Swing Trading Stock Trend Channels
The trend channel trading strategy is effective and highly visual. I also really like the cup and handle strategy.
A trend channel occurs when the price has bounced off a rising trendline at least three times or more. The price also tends to fall after hitting an upper trendline drawn along the price swing highs. A trade (buying opportunity) occurs on the fourth touch point of the lower trendline.
The following daily chart shows a rising trend channel. The price tends to rise off the lower trendline, and then fall at the upper channel.
Charts from TradingView.
For the purposes of this strategy, a trendline is drawn once there are three bottoms that can be connected with the trendline. The trendline is then extended off to the right. The trendline only needs to intersect near all three lows. It doesn’t need to perfectly connect all three exact low points (more on this later).
An upper trendline can drawn once there are three swing highs. A line is drawn along the top of the those swing highs and extended out to the right.
When I draw a trendline for this strategy, it is a line of best fit. That means I don’t draw the line right along the highs or right along the lows. Instead, I make sure the trendline touches near all the significant reversal points.
The chart above shows a best-fit channel. The best fit channel highlights the general movement of the stock. It is not meant to tell us exactly when to trade. It is just meant to give us an idea of how the stock is moving.
If we don’t use a best-fit channel our chart can start to look pretty ugly as we continually have to redraw lines in order to match recent lows/highs with prior ones.
Or, if we just try to connect one swing low/high with a later swing high, may end up disregarding some of the price swings, which means our channel may not be very accurate or helpful (for this strategy) going forward. There are multiple thumbs-down on the chart below compared to the best-fit chart where there are none.
Go back up and look at the first chart with all the thumbs up. The “best fit” approach is a slightly different way to draw the lines, but WAY more helpful (at least for this method, and with my trading style).
Now that you know how to draw and spot a trend channel, you are in a position to start learning how to buy near the bottom of the channel, and where to sell near the top of the channel.
For an idea on how this strategy performed, I publically published trade signals for 31 weeks several years back. It returned 49% over that time frame. Not all the trades could have been taken (because some weeks there are too many so capital would have already been fully deployed), so the actual result would be a bit lower, but it shows the power of this simple strategy.
How and Where to Enter a Swing Trading Stock
The basic idea of the trend channel swing trading strategy is to buy near the bottom of the trend channel. BUT if you do that with no other criteria you will lose a lot of money very quickly.
We need some sort of signal near the bottom of the trend channel that tells us “Now is the time to buy.” This is called a trade trigger.
My favorite entry method is to wait for a consolidation near the bottom of the trend channel. A consolidation is when the the price moves predominantly sideways for more than a couple of days.
The consolidation should occur near the bottom, or even slightly below, the trendline of best fit.
Buy when the price moves above the high price of the consolidation.
You don’t need to sit watching your screen. Once you have identified a consolidation near the lower trendline, place a buy stop limit order a few cents above the consolidation-high price.
On the third box on the right (chart above), the two-period consolidation high is $191.75. Place a buy stop limit order at $191.80, with a limit of $192. This is the fourth touchpoint on the trendline (including the start), which is a good point to start trading. You can trade on the third, but I don’t because the win rate tends be a lower on the third touchpoint. The price has only bounced off the trendline once, and we are guessing it will again. By the fourth touchpoint, the price has bounced off the line twice, and thus the trend channel is becoming more firmly entrenched.
This type of order gets us into a trade when the price reaches a specific level ($191.80) but also controls how much we pay ($192). Controlling how much we pay is important. Imagine for a moment that you want to buy when the price moves above $191.80, but the next morning the price gaps* higher and opens at $195. If you only place a buy stop at $191.80, with no limit on the price you pay, you will end up paying $195. That is a lot higher than you expected.
As we will discuss a little later on when we talk about risk and reward, when we end up with a worse price than we were looking for, that means our potential profit is now smaller. As you may have guessed, we’re going to exit near the top of the channel. If we end up buying in the middle of the channel instead of near the bottom, most of our profit potential has disappeared.
*A gap higher is when the open price the next day is above the close of the prior day. Gaps occur all the time, but big ones—when there is a big price difference between the open and close—can cause problems if we are trying to get in near a specific price level.
How and Where to Exit a Trend Channel Trade
We have our entry nailed down. We also need to know where our exit will be. We determine where, or at least how, we will get out of a trade before we take it.
We need an exit plan for if the trade turns profitable (profit target), and we will need an exit plan for if the trade starts losing money (stop loss).
Trend Channel Strategy Stop Loss
A stop loss is how we control risk. For a long position, a stop loss is an order to sell if the price reaches a specified price or below.
For this strategy, we are going to place the stop loss several cents below the low of the consolidation (if going long).
Since the price has to form a consolidation, and our entry and stop loss are based on that consolidation, we know both these levels before we take a trade.
The first trade above is actually the fourth touchpoint in a larger channel (earlier starting point). After that trade occurred, I adjusted the channel to the one above because it fit the recent swing lows a bit better. So it is ok to update your channels if the original trendline is starting to look a little wonky, and there are at least three touchpoints to draw a new trendline extending off to the right.
Trend Channel Strategy Profit Target
We also need to establish were we will exit if the trade proceeds as planned and moves toward the top of the channel.
The simple answer is at the top of the channel. But where along the top of the channel? The upper trendline extends out to the right indefinitely, going up and up and up.
The conservative estimate is to place the target at the top of the channel when you place the trade. That means you look at what price the upper trendline intersects directly above your entry point.
That’s a good method if you are starting out.
As you become a bit more advanced you can add in some other tools, such as measuring how long prior advances took, or how far they ran.
I discuss some other exit methods in the Complete Method Stock Swing Trading Course along with some other tips on when to avoid trend channel trades.
The Early Exit
Regardless of how close or far the stock is from the stop loss or profit target, exit every trade the day before earnings announcements.
Earnings announcements can cause large gaps in the stock price, meaning you could end losing much more than you expected if the price gaps below your stop loss. A stock can gap 10%, 20%, or even 50% or more on an earnings announcement….even in seemingly stable companies.
I recommend you make the above rule mandatory.
Risk/Reward When Swing Trading Stocks
We have looked at entry points, stop losses, and profit targets. Now we need to discuss how those three points relate to each other.
When swing trading, I am typically not interested in a trade unless my potential profit (the difference between profit target and entry point) is at least three times my risk (the difference between the entry point and stop loss).
TradingView Charts offer a cool “long position” or “short position” tool that allows you to set your entry, stop loss, and profit target so you can see it visually, and it also calculates your reward:risk.
It’s important to notice the process of how we determine our reward:risk. We don’t pick a reward:risk ratio and then pick our stop loss or profit target based on it. We analyze the stock and pick our entry, stop loss, and profit target based on that analysis first. We then determine the reward:risk. Only if the reward:risk is attractive to us do we take the trade.
If the reward:risk isn’t attractive, look for a better trade.
It may be possible to adjust trade levels slightly to get a more favorable R:R, but don’t make the mistake of expanding your profit target to a level where it is unlikely to get hit. Trust your analysis, your channel, and try to keep the target relatively conservative (compared to the trend channel and price waves in it) so that target remains likely to get hit.
There is another important element to consider: you have found trade; how many shares do you buy?
How many shares you buy or dollars you invest in the trade is your position size. It should be based on a formula, not randomness.
Read How to Position Size When Swing Trading Stocks for a proper method for determining your position size.
How to Scan or Find Swing Trading Stocks
I love this trend channel strategy because it is one of the easiest ones to scan for.
Scanning or filtering is a process by which we find stocks that could meet our strategy requirements. For this strategy, our main goal is to find stocks in trend channels.
Once we have a list of stocks in trend channels, we can look through them to see which ones are near an entry point and which ones offer a favorable reward:risk.
One of the easiest ways to find trend channels is to use the Finviz screening tool. Most of the features are free, although I have been an Elite version subscriber for added functionality. Some other scanners may also allow you to search for technical patterns, such as trend channels.
- From the Signal drop-down, choose Channel Up for stocks currently moving in trend channels higher. If looking to use this strategy in downtrend stocks (to short), select Channel Down.
- For Average Volume, select Over 100K. We don’t want to trade stocks with very little volume. This is optional.
- For Industry, select Stocks only (ex-Funds). If you don’t mind trading ETFs, and you can with this strategy, leave this blank. This is an optional criteria.
- Price > $5. This is optional if you want to avoid penny stocks.
- To only see stocks in likely uptrends, add a criteria for Price above SMA200.
Click on Charts mode, and Type=Technical in order to see charts of all the stocks. Finviz draws their own channels. These are just a guide. It is up to you draw the channels, as described, on stocks that may meet the strategy parameters.
Run through this screener once or twice a week looking for stocks that meet the strategy criteria.
Here is an example.
At the time of this scan, you can see that LULU is on the list. It is near the top of the channel, but it was also on the list when it was near the bottom of the channel, providing our trade example for this article.
AUDC is in a nice position for a swing trade, although at the time of this screenshot it has earnings coming out within a couple of days, so the trade is ignored for now. If a valid trend channel trade is still presenting itself after the earnings announcement the trade could be considered. For something like this, I would jot the stock down, along with the earnings date, and then take a look at it after earnings. It if still presents a good trade, awesome. If not, look for others.
Some days you will find several quality trades when you scan, other days you will find none. Sometimes you won’t find any for weeks. Stay strong, and make sure you only take trades that align with the strategy. Not having a trade is better than taking a crappy one that will lose you money.
How to Swing Trade Trend Channel Stocks – Tying It All Up
Go through the list of stocks in the scanner (I use Finviz for this strategy) looking for stocks in nice rising channels and where the stock is currently near the bottom of the channel.
If a stock is of interest, pull up a big chart of it (I use TradingView), draw your own lines, and look for potential trade levels (entry, stop loss, and profit target).
In order to take a trade, the Reward:Risk should ideally be 3:1 or more.
If a stock meets all these criteria, determine the position size based on the position size formula.
Make sure earnings aren’t coming out soon. If earnings come out in a few days this won’t give enough time for your trade to reach the target.
Then, place your orders.
This is one strategy. Practice it and it will serve you well when trend channels are present.
By Cory Mitchell
The Complete Stock Swing Trading Course by Cory Mitchell, CMT focuses on 4 patterns that tend to occur in strong stocks right before an explosive move.
Learn how to read market conditions, how to find potentially explosive trades, where to get in and get out, how to fine-tune trade selection, and how to manage risk.
This is a complete method for swing trading stocks, revealed in step-by-step video format.