25 Feb 2021
Channel formations are used consistently when drawing up charts for cryptocurrency technical analysis. The channel formations accurately show the current trend direction of a cryptocurrency; whether it is over-extended or whether possible reversals may be just around the corner. Channel formations can be bearish, bullish or neutral.
When looking at channel formations there are three main types. There are ascending, descending and horizontal channel formations.
Channel formations are made up of two lines
The first line is a resistance line. The resistance line is what is forcing the price of a cryptocurrency down. Therefore in the example below, the overhead resistance is preventing BTC from breaking above $9500 USD. The resistance is marked on the chart below.
The second part of a channel formation is the support. Support is what holds the price of a cryptocurrency up. Below on the screenshot we can see that there is channel support at $9000 USD for BTC, preventing the cryptocurrency from falling further.
BTC/USD channel example
Looking closer at each type of channel formation
An ascending channel has two lines. These are ascending support and ascending resistance lines. When an ascending support is seen, the cryptocurrency is in a bullish trend until a downward breakout occurs.
Ascending channels typically tend to see bearish breakouts, closing below the ascending support which was previously holding up the price.
Below we can see an example of an ascending channel. In this example we see BTC find support at $9000 USD before entering the channel. From here BTC then made a move up to $10500 USD until a break below the channel saw BTC lose 11% of its value in 7 days. The break below was a bearish signal.
When cryptocurrencies break below a descending channel, retests of the channel are typically seen. In this example BTC saw a retest, heading back up to $10300 USD. From here BTC then formed a bearish head and shoulders formation, further confirming the bearish sentiment.
BTC/USD ascending channel
Descending channels are the opposite of ascending channels. The cryptocurrency is locked in a downwards movement.
The downwards resistance line pushes the cryptocurrency down, although the downwards support prevents further losses.
Generally, a cryptocurrency will break out of a descending channel in a positive direction with the first target typically being the 0.5 fibonacci retracement, which when broken above tends to confirm that a cryptocurrency is in a bullish trend.
BTC/USD descending channel
Below we can see an example of a horizontal channel. This typically shows that there is a fight between the bulls and the bears, neither have a real grip on the situation.
The cryptocurrency will move between these two levels; the horizontal resistance and the horizontal support.
The breakout direction will then show whether the bulls or bears have won. In this example we can see that the bulls won, with BTC then going on a significant rally.
BTC/USD horizontal channel
When in a horizontal channel, indicators will generally be useless and give off numerous false signals. Below we can see an example with the MACD. Due to it being a lagging indicator, it is highly ineffective during sideways periods. Buy signals are marked with the green vertical lines and sell signals with the red vertical lines.
This is why it is good to use the MACD alongside the volatility indicator, as horizontal channels generally have low volatility.
All in all, channels are an effective way to determine the current trend of a cryptocurrency. They are also helpful in spotting potential trend reversals due to the angled resistance levels acting as trend lines.
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