Price Action: Microchannels (Part 1)

A microchannel is a move with no pullbacks, or with very few and very shallow pullbacks. As soon as price drops below the prior low, or in a rally breaks above the prior high, the microchannel ends and is redefined as a tight channel. A microchannel represents a breakout move on the current time frame, while a tight channel may also be a breakout move on a higher time frame.

For example, on a 5-minute chart, if five consecutive bars do not drop below the prior low, this is a breakout move on the current time frame. Once there is a downward break below the prior low, the breakout move ends and the microchannel ends with it. A strict definition makes it easier to determine when the microchannel has been broken and the market is entering the next phase.

The importance of microchannels lies in the fact that their breakouts often fail. When many consecutive trend bars line up in the same direction, the probability of a counter-trend breakout is usually low — it is more likely to fail and resume the original direction. The characteristic of a tight channel is that pullbacks are few or small, the trendline can closely track the price movement, the two boundary lines are very close together, and price runs along the trendline.

On higher time frames, a tight channel is often a breakout move. Understanding this is important because breakout moves often have a second leg extension. This means that even if the current time frame shows overlap and appears ready to pull back, after the pullback ends, the move is more likely to continue. For example, a pullback on the current time frame lasting only two bars may still continue upward and form a second leg after breaking below the prior low. Therefore, when you see a tight channel on the current time frame, realize that on a higher time frame it may be a breakout move, and your expectation should lean toward continuation. Since a tight channel is a breakout move on a higher time frame, a trendline break often fails, and the market may enter a trading range before continuing in the original trend direction.