A 4 Hour Channel EUR/JPY  

As I have my 216 pips this week, I am just looking at charts for the heck of it. I looked at a 4 hour chart, which I never use for active trading, and I saw a well formed channel. I want to ananlyse that channel and to say how it could be traded and then also what the dangers are.

First the chart:

The channel is drawn by recognizing high point A and high point B. A trend line is drawn on those two points. Then a parallel trend line is drawn starting at Point C. This can be done in real time if you are looking for it. The Bottom trend line is the ultimate target.

Unfortunately, price does not move in a straight line. Before price reaches the bottom of the channel 730 pips lower, it will drop and pullback and drop and pull back in moves of several hundred pips in each direction. An intermediate target is needed or even several targets. Rob Booker teaches (and developed I believe) targets inside the channel based on Fibonacci Retracement levels of 38.2%, 50.0%, and 61.8%. These are drawn as pink dashed lines on the chart. Rob's term for these lines is Fibbles.

Of particular note is the 50% Fibble which is the center line. Notice how price reacts at that line. When I draw channels in real time, I will look to see how precise the reaction is at the 50% Fibble between price at Point C to price at Point B. If there is clear reaction I will assume the channel is valid.

I can then take my trade going short sometime after Point B with my target being the 38.2% Fibble or the 50.0% Fibble. Note that the earliest entry for a short trade is after Point B is confirmed as a high point by a bearish close of the candle. I labeled this as "1" with the take profit point as "2".

Once inside the range bounded by the 38.2 and 61.8 Fibbles, price can go either direction unpredictably. It is not wise to enter a trade in that no mans land. Except when.....

Price drops dramatically and then pulls back. Once price has gone down far enough, then I will go short again after a significant pull back.

How do I know what "far enough" is? It is a candle closing well below the 62 EMA and in the range of the 61.8 retracement level (not the 61.8 Fibble but rather a standard horizontal retracement.)

How do I know what a "significant pullback" is? It is reaching the 50% Fibble. At the touch of the 50% Fibble I will have a trade short trade set up (a Sell Limit).

My ultimate target is the bottom of the channel. But in the first touch on the 50% Fibble I am running out of day and week as it occurs on the Thursday before Good Friday. I would close the trade. I never suggest a carry trade. (Though I carry trades on a Demo Account as part of my "What IF..." experimentation/dinking around).

On the week open, price again reaches up to touch the 50% Fibble from the bottom. Go short Baby go short!

There are problems with this analysis from hindsight though. The next chart will illustrate.


Point B1 is the high of a bearish candle. If I were watching the chart in real time, it is near the close of that candle that I can venture to draw the upper trend line and then the lower parallel trend line begins at Point C. The candle closes. I say to myself "Hey SELF!!! Look what we've got here! Its a 750 pip channel and we are near the top. SELL, SELL, SELL!!"

So I go short while simultaneously wetting my pants in excitement and anticipation.

[Now begins the alternate scenario] But then price doesn't go down. It goes up. And Up. And Up. Finally, it hits point B2. I am down 200 pips. What went wrong?

I went against the trend. Or more accurately, Point B1 wasn't the high point in the channel. Point B2 was the real high. A new channel is illustrated by the Khaki-colored dashed lines. Notice that the reaction at the 50% Fibble is still valid between Point C and Point B2. Everything that was valid in the first chart is still valid in the alternate scenario. I just chose point B prematurely.

This is a real danger in trying to spot channels in real time. What is the peak (or bottom if the trend is down) marked by point B. If I choose B correctly, then I will make a whole lot of pips. In hindsight, Point B is obvious. But often too much time has passed to take that first trade. In real time it is very, very difficult to know when a peak has just occurred.

Another problem with trading on the 4 hr chart, is that the moves good and bad can be huge. A swing of 100-150 pips against your position does not invalidate the analysis. To endure the swings of price when based upon 4 hr indicators, a stop of 200-300 pips is necessary. If you tried a stop of 50 pips, I can assure you that 90% of your trades will stop out.

A rule of thumb is, indicators in higher time frames (4 hr and higher) will be more accurate but the stops will need to be 4X greater than required in lower time frames (1 hr or less).

I don't trade based upon higher time frames. I am happy to take a trade for 17 pips. My most frequent target is 40 pips and my best trades are made in much less than 4 hours.