In the previous blogposts, I wrote about how to use trendlines to identify changes in stock trends and the significance a trendline carries.
This week we are going to look at a very important concept that can help you to ride long term compounding stories- Parallel channels.
How to identify a Parallel Channel?
Previously, I wrote about how you can join higher lows to draw an upward sloping trendline and how you can join lower highs to draw a downward sloping trendline.
Now, to draw a parallel channel all you need to do is draw a parallel line to the upward sloping trendline or a downward sloping trendline. The upper end of the channel indicates ‘Resistance’ and the lower end of the channel indicates ‘Support’. Depending on the timeframe you are looking at, the significance of the channel resistance and support would vary. The longer the timeframe, the stronger the resistance/support.
How to identify the significance of a Parallel Channel?
In order to draw a parallel channel, you will need at least two touchpoints on one side of the channel. However, a channel becomes very significant when it has at least two touch points on BOTH sides.
Let’s take the example of Maruti. Here you can see how the stock is trending beautifully in a long term multi-year parallel channel. Every time the price reaches the lower end or the upper end of the channel, the price tends to reverse or go sideways. The support and resistance act beautifully because it is a multi-year channel. Had it been a channel that was formed over a period of few days/months, there is a higher chance that it might give away.
Stocks that are fundamentally strong long term growth stories tend to trade in a parallel channels. So, the next time you identify a stock that is at the lower end of the channel, you know that it is probably a good time to buy. Here is one such stock I identified this week – Exide industries. This stock is trading in a 25-year long parallel channel!
In general, there is a high probability that consumption stocks in India will be already trending in a long term parallel channel just because of the strong long term growth prospects. So, if you are waiting for a very significant drop, it is very unlikely to happen.
Consumption Stocks Examples
Here is one of my tweets that you can refer to for many such consumption stocks that are trending in a parallel channel.
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