Price Action: Trading Broad Bull Channels (Part 2)

In a bull trend,
you must assume most reversals will fail.
If you can identify a broad bull channel earlier,
that is even better.
It allows you to enter swing trades earlier.

Because pullbacks are usually deep,
bears can make money by going short on rallies,
such as pullbacks from new high reversals.
You must also expect weak follow-through after new highs,
because bears will sell at the high
and bulls will also take profits at the high.

But as long as it has not truly become a bear trend,
traders will buy on breakouts below the prior low.

A very strong bear breakout —
at some point, the market enters an "Always In Short" state,
meaning the market may fall further.
However, once price drops near the bottom of the trading range,
specifically near the most important "major higher low" on the left side,
bears need this decline to continue.

If price stalls and reverses up,
traders will assume bears will cover their shorts and bulls will enter long,
either expecting the trading range to continue
or expecting the bull trend to resume.

Trading ranges often produce a very strong second leg down.
For example, the first leg down, then a stronger second leg;
or the first leg down here, then a stronger second leg.
I call this the "second leg trap."

It tricks traders into thinking bears have won,
that we have entered a bear trend,
and that this breakout will be the start of a prolonged bear trend.
But in reality, it only lures some weak traders into selling near the low.
The second leg trap is very common in trading ranges
and very common in broad bull channels.

Every bull trend needs to form a series of higher highs and higher lows,
especially "major higher lows."
A "major higher low" refers to a relatively strong higher low
that is typically followed by a breakout to a new high.

As long as the market continues to form "major higher lows,"
it is still in a bull trend or trading range.
Once it drops below a "major higher low,"
it is no longer a bull trend
but has become a bear trend or trading range.

If it reverses up strongly,
then it returns to a bull trend.
As long as these reversals stay above this low,
bulls may still be in a "broad bull channel."

If you can determine early what the market is doing,
it will help your profitability.
It allows you to make the right trades early.

Whenever I look at a chart,
I am always thinking about which stage of the market cycle we are in:
breakout, reversal, channel, or trading range?

Sometimes the market is in several states simultaneously.
For example, after a sideways market, three consecutive bull bars appear,
two of which are large bull bars closing at their highs,
breaking above this "lower high."
At this point, the market has clearly entered an "Always In Long" state.

As long as the market stays above the bottom of this bull trend,
any pullback is very likely just a bear leg within the trading range.

If bulls exit their long positions after three or four consecutive bear bars,
they will wait for a strong bull bar to appear before buying again.
They know the downside risk is not large.

After a big up–big down, sideways is more likely,
unless we drop below this low.
Bulls will assume that even if bears are strong,
it is just a bear leg within the trading range,
which will be followed by a bull leg,
or the trend will resume upward.
Therefore, bulls are willing to buy on upward reversals.

A trading range showing "lower highs and higher lows"
forms a triangle.
In a broad bull channel, the market often consolidates sideways for a long time.

Although no higher highs are being made,
higher lows continue to form.

How do you determine the market is in a "broad bull channel"?
Usually you need to see at least three rally legs.
But often by the time you see three rally legs,
it also constitutes a wedge structure that may lead to a reversal.

Traders will expect the market to produce two down legs next,
but they cannot yet say the market is "Always In Short."
Sideways is more likely than a decline.

Often when you look at a chart, you cannot determine
whether it is a broad bull channel, a trading range, or a wedge.
In that case, just trade the structures you can clearly see.
And you often need to wait for the structure to develop further before gaining more confidence.

A typical characteristic of a broad bull channel
is that when price breaks to new highs, follow-through is usually weak.
This is because bulls take profits at new highs —
they prefer to buy on pullbacks rather than chase highs —
and bears go short at new highs.