Sharemarket book

2. ChannelSurfing
Riding the Waves
of Channels to Profitable Trading
by
Michael J. Parsons
authOrrlOUSE"
1663 £tHER7YDRIVE, SUITE200
BLOOMINGTON, INDIANA 47403
(800) 839-8640
wwW.AUTHORHouSE.COM

3. © 2005 Michael J. Parsons. All Rights Reserved.
No part of this book may be reproduced, stored in a retrieval system, or transmitted by
any means without the written permission of the author.
First published by AuthorHouse 03/16/05
ISBN: 1-4208-3312-X (sc)
Printed in the United States of America
Bloomington, Indiana
This book is printed on acid-free paper.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used
their best efforts in preparing this book, they make no representations or warranties
with respect to the accuracy or completeness of the contents of this book and specifi­
cally disclaim any implied warranties of merchantability orfitness for a particular pur­
pose. No warranty may be created or extended by sales representatives or wrillen sales
materials. The advice and strategies contained herein may not be suitable for your situ­
ation. You should consult with a professional where appropriate. Neither the publisher
nor the author shall be liable for any loss of profit or any other commercial damages,
including but not limited to special, incidental, consequential, or other damages.
It should not be assumed that the methods, techniques, or indicators presented in this
book will be profitable or that they will not result in losses. Past results are not neces­
sarily indicative of future results. Examples in this book are for educational purposes
only. This is not a solicitation of any order to buy or sell.
The National Futures Association (NFA) requires us to state that "Hypothetical or
simulated performance results have certain inherent limitations. Unlike an actual
performance record, simulated results do not represent actual trading. Also, since the
trades have not actually been executed, the results may have under or over compensat­
ed for the impact, ifany, of certain market factors, such as lack of liquidity. Simulated
trading programs in general are also subject to the fact that they are designed with the
benefit of hindsight. No representation is being made that any account will or is likely
to achieve profits or losses similar to these shown."

4. To my mother Peggy whose legacy still impacts this world
for good more than a quarter ofa century after she left
it and my wife Ruth who stood by me through all the
good, the bad and the ugly this world had to offer.
v

6. Table of Contents
1. Channel Surfing - The Basic Concept ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ]
2. Breaking Waves. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3. Kiss ofthe Channel Line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
4. Major Price Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . .. . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . 59
5. Determining Balance Of Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
6. Doing the Math - Setting Stops and Calculating the Waves . . . . . . . . . . . 85
7. Multiple Time Frames . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
8. The Repeating Channel and Trend Angle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
9. True Support and Resistance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
]0. Trading Options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 55
II. Putting It All Together . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181
VlI

8. Introduction
Trading is a blessing and a curse. It is a blessing in that no other occupation
can be more exciting and rewarding than trading. You literally can become
a millionaire overnight or at least in a very short period oftime. On the other
hand, trading is a curse because it is more likely that you will make someone
else rich long before you have any real success. It is without a doubt the most
expensive education you can obtain. In the process of educating yourself
it can destroy your marriage, your retirement, your home ownership and
many other things that take a lifetime to acquire. Poor money management,
inability to control one's emotions and a clueless approach to trading leads
manydown the road to the poor house paved in fool's gold. It may look great
to walk on, but who really wants to go there?
My own introduction to this blessing and curse came from a man in a
cowboy hat that made trading sound like child's play. Very quickly I
realized that I was in over my head and that this man probably would
have sold me the Brooklyn Bridge if given half a chance. Since then I
have hit rock bottom twice while trading. (A nice way of saying I lost it
all) After my last fiasco, I decided since I couldn't find any method that
worked to my satisfaction, that is a method that actually made money,
I would discover one for myself. This lead to a number of observations
and discoveries of how the market works, why it behaves the way it does
and more importantly, several methods that actually work that are based
on the geometry of the market. Channel Surfing is one of those methods,
providing an in-depth understanding of the markets that you will rarely
find elsewhere.
As you read this book you can expect to learn the following:
1. The basic concepts of Channel Surfing, presented in a way
that is easy to understand and easy to apply.
2. Why channels are a natural phenomenon and how to take full
advantage ofthis.
3. How to take the basic concepts of Channel Surfing and
catapult it into an even more powerful method of trading
using advanced techniques.
4. Additional tricks to reading the geometry of the market that
add to your success.
IX

9. While there exists an endless array of indicators available to use in
this day and age, most have one common failing; they fail to adapt to
changing market conditions. Channel Surfing succeeds in adapting to
market conditions because channels are actually weaved by the market
itself. Price rarely moves in a straight line, therefore channels provide the
ultimate momentum indicator.
Despite its adaptability, Channel Surfing continues to outperform many of
the most popular indicators in use today, time and time again. The beauty
of it is that it doesn't require you to suffer through large drawdowns in
order to realize a profit. In fact, it is so effective that it is probably the very
best approach for beginning traders and those with very little capital. So
just imagine what an experienced and well-funded trader can do with it!
Although a parallel is made with actual surfing, this is a methodology
that is about something very serious, trading profitably. But obviously the
more success you have and the greater your confidence in your ability to
extract a profit, the more pleasurable it becomes. Success and confidence
are directly influenced by your ability to understand the market that you
are trading. To that end each chapter of this book will take you step by
step through the process of reading the language of the markets. Put into
practice an individual can look at a market and recognize how it is likely
to behave and react to the various situations that arise, a skill that often
takes decades for a person to develop.
Chapter one begins by covering the basic concepts of Channel Surfing,
with nineteen illustrations that make it easy to comprehend. Five different
entry methods are covered, along with two exits. These basic concepts
alone can dramatically improve a person's trading success, but this is only
the begioning.
Chapter two describes several specific entry methods that enhance the
basics and provides more opportunities to enter a market with low risk.
Chapter three delves into an important price phenomenon that can be
exploited for profit. It also takes a closer look at the psychological aspects
of trading and how they impact success.
Chapter four examines major price levels, which include much more
than just support and resistance. Major Price levels impact how trading
decisions are made and can even contradict normal guidelines, so they are
discussed in detail.
x

10. In chapter five the balance of power is discussed. What is the secret to
knowing the bias of a market? The answer is detailed here from the most
subtle indications on up to the larger and stronger signals.
The math of Channel Surfing is covered in chapter six. Calculations are
a requirement if you want to provide specific entry and exit numbers to a
broker, but they also provide several other advantages as welL.
Chapter sevcn elevates Channel Surfing to another level by using multiple
time frames as a basis for trading decisions. This one technique will
dramatically increase the odds ofsuccess in any trade you consider.
Chapter eight brings a series of additional techniques to the table that
enhances trading even further. Simple and effective, they provide
additional tools to your trading arsenal that will cut down to size any
market that is stubbornly refusing to be analyzed.
Chapter ninc is a real eyc opener and after reading it you will never look
at a chart the same way again. True support and resistance flies in the face
of traditional technical analysis, but it has proven itself time after time.
Practically every consolidation pattern, reversal and acceleration can be
understood and even predicted by using this invaluable method ofreading
a market.
In chapter ten options are discussed. Options offer a great opportunity for
profit if you can accurately identify where a market will go and when it
will be therc. How to determine these key factors are outlined.
Chapter eleven brings everything together providing several trading
examples that show how to effectively use these methods. A sobering look
atthe reality oftrading is discussed, as well as some additional factors that
will impact trading success.
The techniques and methods discussed in this book provide a complete
trading plan that improves as the skill of the user improves. More than
what is needed is discussed so that an individual can adopt what fits their
particular style oftrading. But initially the most conservative techniques
should be utilized. For example, some entries described in this book can
be very aggressive and have been identified as such. While such high-risk
entries are at times discussed, several that are low-risk are emphasized
throughout this entire book that will provide plenty of profitable trades
without the need of such aggressive tactics. So initially focusing on the
conservative techniques is strongly encouraged.
Xl

11. Channel Surfing is a solid foundation for understanding the language
of the markets. Even though my research has led to other advanced and
powerful trading techniques, I still return to Channel Surfing whenever
I first look at a chart. I am convinced that it will become your first and
favorite choice when you look at a chart as well. For all its simplicity it
remains an exceptionally powerful technique because it keeps losses low
and profits high. I wouldn't trade without it.
Besides, what could be more fun than surfing? Especially when it is
profitable!
Xli

12. Chapter One
Channel Surfing - The Basic Concept
A surfer surfing a wave, a sailboat sailing with the wind and a glider
soaring an updraft all have one thing in common. They catch and ride
natural forces in motion. Yet, a surfer has no more control over a wave
than a sailboat can direct the wind. They simply take advantage of forces
that already exist for their benefit.
It is no different for a trader. During the course of a long and successful
career in trading an individual will weather many storms and lulls in the
markets and face many updrafts and down drafts. No one can dictate how
the market will act, but that doesn't mean that we can't learn how to take
advantage ofthe forces that develop.
Have you ever seen what a surfer does when a storm brews? As a storm
hits a coastal area most beachcombers will avoid the beach. But a surfer
sees this as an opportunity and they will come out in droves like sharks
circling bait in hope ofsurfing larger and betterwaves. In a sense, trading
is the same because a market storm can result in some wild swings and
potentially offer an exceptionally high return. For an inexperienced surfer,
such a storm could mean a wipe�)Utjust as surely as a stormy market often
does for an inexperienced trader. In contrast, a storm for an experienced
surfer can mean the ride of his life, just as a wild market can mean a
windfall for an experienced trader.
In many ways the market behaves just like the waves of an ocean, so
forming a parallel between a surfer and a trader is as natural as a wave
breaking along a beach. The similarities between surfers and traders are

13. Michael 1. Parsons
uncanny. A surfer will wait until he finds the best wave, time his entry,
ride that wave as long as he can balance on it and then go back out to
catch another wave. Guess what a successful trader does? He waits for
and chooses the best market, times his entry, rides that market as far as
he can manage and when the ride is over he starts the whole process all
over agam.
Throughout this book you find many references to the similarities that
exist between surfing and trading. But in all seriousness this book is about
a trading method that actually works and has proven to be one of the
easiest to learn, easiest to apply and easiest to follow. Particularly if you
are a beginning trader or have a very limited budget you will appreciate
how this method overcomes your limitations by providing you with low
risk and high return. The analogy to surfing serves to give you a visual
aid to understanding what it takes to be successful in trading. But where
a surfer surfs the waves strictly for fun, you will be surfing the market for
both fun and profit.
So how do you surf the markets? Visualize for a moment a surfer surfing
a wave. He rides a flat board that he balances on the cascade ofa breaking
wave. Initially, he sets up where waves first break at what is known as the
impact zone and makes a wave (catches a ride), and balances for as long
as he can until the wave finally collapses on itself just shy of the beach.
Once the wave dies and slips away from under the surfboard, the ride is
over and its time to set up for the next wave.
Channel lines act as your surfboard and price your wave. As long as your
surfboard rides the price wave, then you just have to keep your balance
and enjoy the ride. When price slips away from your channels then the
ride is over and it is time to set up for your next wave.
In other words, Channel Surfing uses channels to set the parameters for
price movement. For those of us that are mathematically impaired, this is
a graphical way to determine what the market can be expected to do and
not do. The value ofthis is that if it exceeds these parameters then you are
alerted to a change in a market's condition and the need to make a change
in your trading.
Here is how it works: Once a market is moving, you draw a trend line
following the edges ofthe price bars using the highs or lows as your gauge.
Normally, you will need to have at least two highs or two lows to draw
your line from and the more highs or lows to work with, the better. But it
2

14. Channel Surfing
is not a matter ofjust finding the most bars, but rather the bars that outline
the extreme of price activity. So there may only be a few bars to work
with, particularly when a trend is new. However, as a rule the greater the
number of bars that support a trend line, the stronger these lines will be.
On the other side of the price movement you also draw a similar trend
line and thereby, create a channel. In effect, you put a fence around
the price movement and provide a visual range parameter. Each price
bar that follows should be within that channel and whenever you see
a price bar exceed one of those channel lines then you know it is time
to take action.
The highsand lowsyoudraw to create achannel shouldenclose all theprice
movement, so you are looking for the extreme highs and lows that follow
a singular direction. For the length of this book I will be differentiating
between these two lines by referring to them as an outside line or inside
line. By definition, the inside line is the channel line that is always to your
right, whether the trend is up or down. The outside line is the channel
line that is always to your left. So ifyou have an up trend, the inside line
is the supporting line, while the outside line is the resistance line. In a
downtrend, the roles are reversed and the inside line is now resistance
while the outside line is support.
Notice in Figure 1-1 how the channel is drawn and that there is an inside
and outside line that will reverse roles depending on whether you are in a
bull or bear market (up trend or down trend)
The extreme swings of a trend
are used to define a channel
3

15. Michael 1. Parsons
What if the market happens to be in a sideways pattern? The principles
are the same with one exception; channel lines are drawn horizontally
rather than diagonally. When the channel lines are horizontal there isn't
any inside or outside lines. So in this case the channel lines are simply
referred to as the upper and lower channel line. Figure 1-2 demonstrates
how this is done.
Lower Channel Line
QQQ 1 Minute
Exiting with channels
So now that we have a basic concept as to how to draw our channel, how
do we use it?
Success in trading depends on putting the odds in our favor. By this I mean
that we want the odds favoring that the market will go in the direction of
our trade. But we also want the odds favoring profit over loss; that is we
want our losses to be small and our profits high. As in any game you might
play success in trading isn't about making all the points but winning more
points than you lose, or in real life terms, winning more dollars than you
lose. Putting the odds in your favor is not a matter of luck, but a matter of
evaluating the risks, determining what the odds favor and then taking the
position that is favored to win.
The channel is our guide for evaluating our risk, a basis for making our
trading decisions and for weighing the odds ofany trade. As long as price
remains within a channel and moving our way, then the odds are in our
4

16. Channel Sur
fing
favor. But as soon as price extends outside a channel the situation has
changed and so have the odds. It is now time to exit. Exiting is a key
component ofChannel Surfing and it happens to also be a key component
ofsuccessful trading.
Initially, most traders want to focus on their entries, thinking that if they
enter well then they are bound to make a profit. While it is true that entries
can make a substantial impact on any trade the reality is that exits have
an even greater impact. An entry only deals with one thing in your trade,
the starting point. But exits incorporate two elements, the avoidance of
unnecessary losses and the locking in ofprofits.
Just consider one exit fault that can sabotage your success; exiting too
soon. If you exit too early such as just before a market starts to move
in your favor, then it doesn't matter how great of an entry you make
because you stiII take a loss. In like manner, if you exit before a trend
has a chance to finish its run then you miss out on a large part of the
profits. A bad entry can mean a small loss, but a bad exit can mean a
financial disaster.
So if exits arc one of the most important aspects of trading then it is
essential that we understand how to determine our exits properly and
when to exit. So for the next few moments we will be examining how
Channel Surfing determines exits.
Trends tend to offer some ofthe best trading opportunities in trading, so
we will look at one in our first example. Imagine that you have shorted
or sold a market that is in a downward trend. The trend has established a
well formed channel that the market is following perfectly. Suddenly the
market slows down and extends through the inside channel Line and price
bars start to close beyond it, breaking the channel. When this happens the
first rule of Channel Surfing is to get out as soon as possible because this
signals that the market has changed and likely will extend into a sideways
pattern or possibly reverse direction entirely.
Take a look at Figure 1-3. In this chart example I have entered a trade
by shorting (selling) a contract at the point it breaks a support line. As
it drops, channel lines are drawn. Later, the market extends beyond the
inside channel line and an exit is signaled.
5

17. A4ichael J Parsons
A short is taken when the market
breaks an inside channel line and holds
Hewlett Packard
An exit is signaled when the
market breaks out of the channel
- Its time to lock in the profits!
The signal is relatively simple, break the line and you exit. To clarify
this a little, you are looking for an actual break and not just a touching
ofthe line. Price is expected to have contact with the line, but an actual
break where price extends beyond it is another story. This is particularly
true if price not only breaks the line, but price bars actually close
beyond it.
But in Channel Surfing we use two lines, not just one. So what if price
exceeds the opposite line? The answer again is to exit. Even though it may
look like the market is accelerating in your favor, when this line is broken
it usually develops into a reversal. So despite the apparent good fortune,
an exit is still called for.
Notice Figure 1-4 and what happens.
Odds are that by exiting when a channel line is exceeded you are locking
in the highest amount ofprofit. This is particularly true when an outside
line is broken because an accelerated move usually ends in a spike before
reversing direction. This phenomenon occurs because price hits a critical
level and the market over-extends itself. For many unskilled traders this
is a temptation they can't resist, a move that appears to be rocketing out
of control. Only they are in for a surprise because a rocket out of control
usually comes crashing down to the ground. By over-extending itself a
market has in essence doomed itselfto collapse.
6

18. Channel Sur
fing
w .1
A re-entry can be made as a smaller channel
line is broken in the direction ofthe trend
An exit is also signaled when the market
breaks through the outside channel
Hewlett Packard Chartcoul'tesyofMeuStock
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Since we are using two channel lines that require an exit if broken, then
two stop orders would be needed instead ofjust the usually one stop limit.
Additionally, should either exit order be activated, the remaining order
would then need to be cancelled at the same time. Such requirements in
your orders can be placed with a broker, but might be difficult with some
on-line order systems. But aside from these additional requirements, the
method is relatively simply to apply. Stop limit orders are placed just
outside, but close to the channel lines. They cannot be equal to them
because the market is expected to actually reach them and you would be
forced out ofthe market needlessly.
If you are trading daily charts and are able to watch the markets during
the day, then do not exit immediately when an outside channel line is
broken. The reason is that a break ofan outside channel line often leads to
a price spike and a market will tend to move some distance before actually
reversing direction. So sometimes it works to your advantage to wait a
little longer while it extends as far as it will go before exiting your position
and thereby capture more profit. Simply establish a new channel line at the
accelerated rate and follow price until this new and tighter channel line is
broken.
Whether you diligently watch the markets through the day, set a stop
based on a recent high or low, adjust your stop at different intervals as
the day progresses, or simply have an alert that notifies you when price
exceeds a parameter, the idea is to take advantage of the continued move
7

19. Michael 1. Parsons
following a channel break until the trend falters. But even if you take the
easy way out and place a stop just outside the two channel lines, the key is
to keep oneselfprotected from any undue risk. Just make sure your broker
understands that if one order is filled that in turn, the other is canceled or
you will end up entering a market unexpectedly. There are times when
"flipping" your position may be something you would want to do, but
usually this is inadvisable.
From an emotionally standpoint, exiting out of a market when it appears
to be rocketing in your favor is a little hard to accept. After all, the market
is accelerating and most traders would think that this is very positive, not
something negative. So why would you want to exit at this point? Won't
you miss a lot ofprofit?
There are times when you will miss a profit, but look at this realistically;
what usually happens when price exceeds the outside channel? Usually it
turns around and reverses direction. Ifyou tried to hold onto your position
in the hope that it will continue accelerating, then you will most likely
lose a portion ofthat profit. The loss will frequently exceed any profit you
might have gotten by chasing after the market. So unless you are able to
closely monitor the move as it is developing, it is best to leave it alone and
gracefully bow out. There is an exception to this rule that we will cover
much later, but for now the rule is: Exit whenever a channel line is broken,
plain and simple.
A word ofcaution is in orderhere. When a strong trending market exceeds
the outside channel it is a sign for exiting your position, not reversing it. If
the market should continue and gap the result could be a substantial loss.
Discretion is the better part ofvalor here.
When a trend initially begins and the first line of support or resistance
establishes itself there will be a question as to where to draw an outside
channel line, which is used to determine the limit of how far the market
is expected to travel. As this point, simply create a line that is at the same
angle as your first channel line and place this on the solitary high or low
that currently exists on the opposing side. Ifyou have a charting program
that allows it, just duplicate the line and move it into place.
As a trend develops, channel lines tend to run parallel to one another and
so either line can be used to as a gauge for the other. This enables you
to establish the channel parameters very quickly and later on you can
adjust it as necessary to the actual market when the trend becomes fully
8

20. Channel Sur
fing
established. Often there will be a slight variation, but as a rule they will
generally be very close in angle to one another, if not exactly the same.
The exception is ifthere is an imbalance ofpower, which will be discussed
in a later chapter.
In Figure 1-5, the channel line created by the supporting trend line is
duplicated and then moved with the same exact angle to new high. This
completes the channel and provides a starting point to work with. As
other highs are established an adjustment ofthe channel line can be made
accordingly.
Lumber
i 14 � 5 n 1! n,
Resulting in an ___ _
exit near the top '
--.,.
1
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Once a line can be drawn. it can be duplicated !i:�
and used temporarily as the opposing channel ' ;;�
line by placing it on an available high or low
;l�
Clw:t coul'te.y oCM.taStook . ,,'
U }3 lO 1� 2'1 11 , , I U: 15 1 15 21 " , ] 2. 17 1
Because this is only an estimated and temporary channel line rather than an
actual one, there will be a need to allow some leeway as price approaches
it. Price may either fail to reach it or actually exceed it by a small amount.
In either case, price should draw close to the estimated line. If not, then it
could indicate a problem with any trend development. Additionally, while
the line may be broken there should be no substantial move beyond it and
any break should only be short-term. Any excessive break or delay in
reversing would indicate that your parameters are off. Fortunately, you
usually do not have to wait long before you know exactly where a market
permanently sets the outside line. From a trading standpoint, the advantage
of having an estimated channel line is that you know approximately how
far price should move. When price backs away after reaching this line it
will not come as a surprise and create a panic. But there are other reasons
for using an estimated channel line.
9

21. Michael J. Parsons
If price fails to reach this level it would be an early sign that the trend
is too weak, giving you an opportunity to exit before it falls back into
a losing position. Additionally it can help you to avoid excessive draw
down and open up the opportunity to profit twice, taking advantage of
multiple moves covering the same territory. If the distance between the
two channel lines is great enough, then it may be more profitable to exit
near the opposing channel line (even if it is an estimated one) and reenter
when price comes back to your original channel line.
Because Channel Surfing is so flexible, you can adapt it to all markets,
time frames, and market conditions. Figure 1-6 demonstrates how
Channel Surfing can be adjusted for a market that is accelerating. This is
an important aspect ofChannel Surfing because it allows you to always be
one step ahead ofthe market.
Inside c:hannel lines narrow as a
market accelerates, tightening your
stops and protect your profits
Clta.rt ofMetaSlDck
Initially, a trend can develop a wide channel that narrows down as it
accelerates. This acceleration will draw price away from the inside line,
diminishing the value ofthat line. This in turn will require an adjustment
ofthe inside line to match the new parameters, even ifprice shows no signs
ofaltering the outside line. An adjustment is made by drawing a new line
to replace the outdated one. So as a market narrows, you in turn narrow
down your channel line to match it and repeat this as often as necessary.
Because trends have a habit ofrepeating this process several times before
the trend actually ends, you frequently end up with a fan like pattern. The
adjustment of a channel line is a one-way affair that continually tightens
yoUl stops as the market accelerates. Each new fan line becomes the only
10

22. Channel Sur
fing
inside channel line you are concerned with because as soon as the tightest
angle is violated, you exit. Handling market acceleration this way allows
you to closely monitor your trading and protect your profits.
To summarize what we have covered so far; two lines are drawn to enclose
price activity and when price violates either of these lines you exit your
trade. In market acceleration, draw additional new channel lines that form
a fan pattern and exit when the tightest ofthese lines is violated.
These rules for exiting will help you to trade more successfully. But for
these rules to be of any value, we still need a way to enter a market in the
first place. So this is the next area that we will consider.
Entries using channels
Because a wide variety of market conditions can arise, there is in turn a
wide variation of entries that can be chosen. The approach you take will
depend to a large degree on your risk tolerance. So one determining factor
is how aggressive or conservative ofa trader you happen to be. Aggressive
trading would be viewed as trading with greater risk in the hope of more
robust profits, while conservative trading would be viewed as exposing
yourself to much less risk, but in turn, accepting lower profits. Despite
the implications, don't automatically assume that aggressive trading is
always more profitable or that conservative trading always has less risk.
The approach one takes should be based on the conditions of the market
that is he or she is trading just as much as one's own trading style and risk
tolerance.
So the first step is to evaluate whether or not the risk is acceptable to
you. This leads to an important question that needs to be answered before
entering into any trade; what is the potential return as compared to the
risk? This is known as the risk/reward ratio and is a simple mathematical
calculation where you divide the potential reward by the potential risk.
Ideally, you would want a ratio of four to one. In other words, a trade
should have a potential profit that is four times greater than the risk that is
being taken. Now at this juncture you may be asking, how am I supposed
to know what the potential profit will be? Don't worry; you don't have
to be a psychic here. We are not talking about predicting the future, just
estimating the potential move.
11

23. Michael 1. Parsons
There are two factors to determine here. First, you are determining where
you would exit or place your stop. The difference between this figure and
your entry is the risk ofyour trade. Second, you are determining the likely
move ofthe market and the difference between this and your entry provide
your potential reward. This last figure is based on a market's previous
action, any channels that develop, and the current trend. Support and
resistance levels and recent swings provide a gauge of previous market
activity. A larger channel than you are currently trading provides a gauge
of possible price movement and this will be covered in more detail later.
Additionally, channels provide key information about potential trends and
what can be expected. For example, an up trend that has an average move
of ten points each day and today happens to have an expected range from
100 to 110. If we are able to enter below 102 and thereby only risk two
points while having the remaining potential of an 8 point move, then you
would have met the criteria of an acceptable risk/reward ratio.
Why would determining a risk/reward ratio be critical? There are two
important reasons why, money management and controlling the emotional
aspects oftrading. These two also happen to be top ofthe list for destroying
trading success. For example, often a trader will attempt to jump into
a market when it appears to be building momentum and speed. But
commonly this is exactly where a trend will come to an end and reverse
direction. But because the trader entered so far beyond any stop that he
will set, he has to allow a greater amount of risk and when wrong, accept
a much greater loss.
Evenifthe marketgoesyourwayyoucanstill lose money iftherisk/reward
isn't reasonable. Slippage alone can eat away at your profit. Imagine the
frustration you would have ifyou tried to buy at 1000 and actually get filled
at 1002 and then turned around to sell at 1003 only to be filled at 1001.5.
You may have been right about the market and what it would do, but you
still lost money because ofslippage. Breaking even on a trade is still a loss
because you have to pay your broker. Remember that you are trading to
make yourself rich, not your broker. Determining your risk/reward ratio
helps to put the money in your pocket rather than someone else.
The first approach to determining the risk/reward ratio is to simply
calculate the trend average and find an entry that is on the favorable side
of the trend. What this means is that for you to enter on a four to one ratio
you would need to enter within the best quarter of that range. Subtract
the low from the high of a channel to determine a trend average and then
divide this number by four. Add to or subtract from your inside channel
12

24. Channel Sur
fing
line and you know the ideal zone to enter. Ideal is not always practical
and there will be times when a trend will not cooperate with this ratio of
entry, such as during times ofa trend acceleration. In such cases you may
have to accept a greater risk, perhaps attempting to enter when you have
a two to one ratio. Even though this may be required from time to time,
most trends will work with a four to one ratio and an adjustment will not
be necessary. Don't allow a trend that is simply uncooperative for a few
days allow you to fall into the bad habit ofchasing a market. In any event
and regardless of the trade situation, you should always have a greater
potential reward than any risk. If you have an equal risk/reward ratio then
it is no better than just flipping a coin.
Once you have an acceptable risk/reward ratio, the next step is to enter.
There are five specific entries that we will be focusing on in this chapter.
There is an aggressive and conservative entry, each with its own specific
rules. Additionally, there is an inside entry that borrows from both of
these entries. Finally, there arc two other entries called the rebound entry
(sometimes referred as the "kiss entry" for short) and the trend entry,
which is used for entering after a trend has been established. Initially, the
focus should be on the conservative entry and the last two entries (kiss
and trend entries) because they provide the least amount of risk. So these
three entries should be learned first, even though two are actually listed
last. In the following chapter some additional entries will be expanded on
that are designed to adapt to breakout situations that frequently arise.
Conservative Entry
The rule for a conservative entry is as follows:
Enter when an inside channel line is broken and price bars close
beyond that line.
Waiting for price to close beyond a channel line ensures that a break isn't
just arogue spike. Further, it usually doesn't hurt to wait for multiple closes
either. A bar close is simply a term that defines where price settled in a
given time period. So the issue here is not whether or not price extended
into an area, but if it stayed there until the next time period began.
While there is a risk of a market rocketing off and leaving you behind
as you wait for the confirmation of a bar close, odds are that it won't. In
fact, a market will usually pull back toward the prior channel line before
13

25. Michael 1. Parsons
continuing with a new trend. In the early stages oftrend formation there is
a strong possibility that a market will give you a false signal. If this were
the case, a premature entry would put you on the wrong side ofthe market.
So this is a good low-risk rule of entry.
To illustrate, if you had been in a downtrend and the inside channel line
(the one acting as resistance) was broken by price followed by price bars
closing beyond that line you would then buy or enter long. In the opposite
scenario of an up trend you would then go short after the inside channel
line were broken and price bars closed beyond the line.
If the market had been in a trading range or sideways pattern and both
your channel lines are horizontal then you would enter when either of
these lines is broken and price closes beyond that line. Figure 1-7 provides
an example ofa conservative entry.
Enter on the
Crude all Ckart
The previous inside channel line now becomes your initially stop. So
the rule then would be that if price exceeds an inside channel line
and then returns back within the prior channel, then your trade is a
bust and you need to exit. A prior channel usual ly works well as a
temporary stop, but there is a problem that can sometimes arise when
using this method. The prior channel line is already headed in the
opposite direction of your trade and so the stop limit will naturally
increase with time, increasing risk right along with it. Obviously
then, an additional limit on your trade is needed. If a new channel has
14

26. Channel Sur
fing
already begun to form in the direction of your trade, even if it is only
partially formed, you can use this to limit the risk.
However, if there were no clear indication of where to place a stop then
a temporary substitute would be necessary. This can be a prior low or
a certain limit based on bar movement, such as a maximum of three
bars against your trade. For example, if you had entered long and each
succeeding bar crept lower, then when a third bar made an additional low
you would then exit. Most briefpullbacks will be three bars or less.
A maximum barlimit is comparable to anotherversion ofa temporary stop,
the time limit. As mentioned earlier, if price lingers excessively without
reversing direction it can be an indication ofa consolidation pattern rather
than a reversal. Sometimes when this happens it is simply better to get out
of a trade when it is convenient. Later, if it does start to go your way you
can look to enter again.
Aggressive Entry
The rule for an aggressive entry is as follows:
Enter when the outside channel line is broken and the developing
secondary channel breaks.
Remember when I said earlier that a spike that extends beyond the outside
channel will often signal a reversal? An aggressive entry takes advantage
ofthis. In this case you are not waiting for any close, but for a spike beyond
the outside channel line to lose momentum and reverse. This approach has
much higher risks and is not for the faint of heart, but ifdone properly can
result in profiting literally from one end of a move to the other. There are
times when this trade should never be attempted, such as when the market
breaks a major high or low or when a report is fueling the move. A market
should have already demonstrated that it is a strong candidate for this type
ofentry even before considering it. Ifa market is prone to wide swings and
sharp reversals then it is worth considering, but if it instead tends to be a
slow moving market or one that has had a strong trend that just won't quit
then it is inadvisable to attempt this entry.
Here is how it works; as a market accelerates it will develop a series of
inside channel lines that fan the market tighter and tighter. Earlier we
discussed this phenomenon and used it to signal an exit for locking in
higher profits. The difference here is that we are now using it to signal
15

27. A1ichae/J Parsons
an entry in the opposite direction of the prevailing trend. To do this
requires that a trading position be very closely monitored, but because
we have a break in the larger outside channel there is already a strong
indication that a reversal can be expected, even if we initially do not
know exactly when this will take place. It is a way of day trading a
market even if you normally do not day trade or an aggressive way
to extract extra profits if you do. This doesn't mean that you have to
suddenly drop everything that you are doing in order to watch the
markets. You are simply looking for an indication that the market
has reversed off the new high or low. Periodically checking a market,
having an alert sent to you, placing an order to enter if the market
moves offa new high or low by a certain amount, or half a dozen other
methods can have you in the market where you need to be. Figure 1-8
illustrates how this is done.
When the outside channel line (Line "A'� breaks. enter as the
accelerated secondary channel line (Line "B'� breaks
CIw1 .rMetaSiock
A word of caution, if you arbitrarily use this entry you will end up
being fooled by false signals and take frequent losses. So there are a
few qualifying factors to look for. First, the channel line should have
been part ofa solid trend that had previously held back numerous price
bars. You need to have a trend that would naturally elicit a strong
reaction when it is broken, so we are not talking about a newly formed
trend here.
Second, the characteristic spike that shows up as the outside channel line
is broken should be an excessively long bar compared to the normal pace
ofthe market. There should be no question that this bar broke the channel
16

28. Channel Sur
fing
because it should stand out like a sore thumb. It should also show clear
signs of reversing off its extreme high or low. The bar must indicate that
it wants to retrace the entire move made by this spike. So you want to see
some type of smaller reversal develop that indicates the extreme move is
over. In any event, be cautious of any prior highs or lows set earlier by a
market. If this bar breaks a major high or low it can have a tendency to
continue the move rather than reverse off of it. So never attempt this at
major resistance or support zones.
Third, price should reverse immediately offof this bar. This entry should
have no delay and each succeeding bar should exhibit a clear change in
direction. Aside from the possibility of a spike that is composed of two
bars rather than one, no other bar should be equal to, much less exceed
it. Any questionable action on the part of price should have you exiting
in post haste. Because it requires the ability to recognize a number of
factors, beginners should avoid this entry altogether. It should only be
attempted by experienced traders who understand the subtleties ofmarket
action. Normally you should avoid high-risk trades, but if done right this
particular entry can offer some powerful returns.
Inside Entry
An inside entry takes something from both of the previous entries. Like
the conservative approach, the entry is signaled with the break of the
inside channel line. But like the aggressive approach, you are entering as
soon as the break occurs rather than waiting for price bars to close beyond
that line.
The rule for an inside entry is as follows:
Enter as soon as an inside channel line is broken.
So as soon as the inside channel line is broken you enter in the direction of
the break. I sometimes refer to this as a passively aggressive entry, which
fits very well but is a term too lengthy to use often. Figure 1-9 shows how
the entry is signaled.
17

29. A{ichae/J. Parsons
at the break of the inside line without
waiting for price to close beyond it
In my own personal trading I tend to favor this approach, but it does
require you to be very alert ofany sign offailure. Just as it is true with the
aggressive approach, an inside entry can frequently lead to false signals if
you arbitrarily use it. Many ofthe qualifying factors to look for are similar
to the aggressive approach, but with a few minor differences. You still
want to see that the channel line was part ofa solid trend and it certainly
doesn't hurt to see a spike ofthe outside channel either. But a spike is not
necessary to actually take this trade. However, it does provide an added
basis for confidence. Either way, this entry still requires you to be nimble
and exit at the first sign oftrouble.
The difference between this entry and the other two has to do with how
the market may develop following the signal. A spike should reverse very
quickly, but a break of the inside channel line may take time to develop.
Price should follow through within a reasonable amount of time, but
remember that it often requires a little time to build a base to launch from.
So the issue is not whether price lingers, but if it lingers excessively. If
what you thought was a reversal turns out to bejust a trading range (which
can be a waste of time to trade) or worse, a pause in the market that leads
to a continuation of the trend, then an exit is called for. But obviously, if
you jump ship too early you could miss out on a boatload of profits. So
anything that happens after the break must be weighed as it develops.
What then is a reasonable amount of time? This is a judgment call based
on market conditions and how a particular market normally behaves, so
1 8

30. Channel Sur
fing
it helps to be well acquainted with the characteristics of the market you
are trading. But there are two characteristics that may develop that will
be important signs. The first is if a market returns to the same high and
low price more than two times. In other words, you should see succeeding
highs or lows, not a return to the same price level repeatedly even ifit isn't
the highest high or lowest low. Failure to make progress implies a trading
range. The second is if price returns to the actual previous high or low
that the market reversed off of in the first place. Neither of these signs is
encouraging. When a trade starts to become questionable it is often best
to look for a convenient exit.
Entries always have risk associated with them and that includes these three.
Even the conservative entry is not always low risk, but these entries are
designed to get you into a market early enough to benefit ful ly from a new
trend. However, a trend can still fall apart and drop into a trading range or
revertto its previous direction. Therefore, you need to always determine what
your exit will be BEFORE you enter any market. This point is extremely
important. If you trade like a cowboy who is shooting from the hip, then
you are likely to be gunned down. Know what your escape route is before
you are caught in the crossfire. Entries are just one aspect of the trading
equation. When market conditions make these entries too risky, then a more
conservative approach is needed. The next two methods of entry provide
this and are the two that I recommend that you start with, adding the rest
later on as your experience grows. So in essence, I have saved the best for
last. They are the rebound entry and the trend entry.
Rebound Entry
The rule for a rebound entry is as follows:
Enter at the break ofthe secondary channel that rebounds toward
the previous inside channel line, as long as it does not exceed the
prior high or low.
This initially sounds a little confusing, but basically what the rule is saying
is that you are waiting for a break of an inside channel that is fol lowed
by the development of a smaller channel that rebounds back toward this
previous inside channel. As long as price does not exceedthe prior channel
high or low, enter when this smaller secondary channel breaks.
19

31. Michael J. Parsons
The theory behind this entry is based on the tendency of price to return
to kiss the previous channel good-bye. Most of the time price will never
actually reach a previous channel l ine, but it will often make a great effort
to do so. As a result, a smaller channel will develop that will angle toward
the previous trend. The outside line of this smaller channel will often be a
little hazy, but the inside line (which is the line we are most concerned with)
will usually be quite easy to define with a simple trend line. When this
smaller channel line is broken you then enter in the direction ofthe break or
opposite ofthe previous trend. Figures 1-10 and 1-1 1 illustrate tbis entry.
Ford
�Secondary Channel that rebounds
back toward the original channel
Original channel
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Secondary Channel rebounds �
back toward the original channel r.r
20

32. Channel Sur
fing
A word ofcaution when using this entry; ifprice in the secondary channel
exceeds the previous high or low established by the prior trend, then the
risk is dramatically increased and the trade should be avoided. At times
price will exceed this priorlevel and the trade still goes on to be successful,
but the odds in favor ofthis are greatly reduced. Additionally, if a market
goes into a trading range it is more likely to continue the prior trend. In
either ofthese cases it is best to look for a point to exit.
If the trade unfolds the way as it is suppose to, then you have reason
for additional confidence in the trade. First, you already have a break in
the original channel, indicating a trend change. Second, you also have
the break of the additional channel, giving more strength and weight to
the trade. But there is an added bonus here. Often a smaller secondary
channel will set up the second point from which an inside channel line for
the entire new trend will be drawn offof. So entering at the break of this
channel will usually be very close to an optimal entry.
So this particular entry offers one ofthe best approaches to entering a new
trend. While there is still no guarantee that the trade will be successful,
this entry offers some extra bonuses thatput more ofthe odds in your favor
which is what trading is all about. Ofall the entries that we have discussed
so far, this is the most important one to learn. This is the preferred entry
when first starting out and the one that I encourage you to use the most. The
prior entries depend on the skill that you develop and are used primarily
with markets that frequently swing. The negative aspect of this trade is
that you will miss a few trades that fail to return to kiss the channel good­
bye. Ifthis should happen, then you need an alternative entry.
Ifyou miss your queue on any ofthe previous entries and a new trend has
already established itself, another approach will be needed that allows
you to enter a trend in progress. Additionally, it is not uncommon to find
long established trends that almost a guarantee a profit if you just enter.
Whether you are dealing with long established trends or short-term swings,
it is always important to enter when there is a low amount of risk. Even
long-term trends come to an end eventually. Although the trend entry still
has risk associated with it, it is perhaps the most conservative and safest
entry ofthe group.
21

33. Michael J. Parsons
Trend Entry
The rule for a trend entry is as follows:
Enter an established trend within one-third nearest to an inside
channel l ine.
What this means is that once the channel lines are established, the average
range is then determined. Entry is then set at a price level that is one-third
or less than that range and nearest to the inside channel line. If a market
is accelerating at a rapid pace, this ratio will tend to be too conservative.
In such a case an alternative would be to use a one-half ratio, entering
whi le in the better half. The actual calculations will be covered in more
detail later, but for now simply focus on mentally gauging this ratio by
visualizing the channel split into thirds and in halves. You don't have to
be perfect, just close.
Despite any apparent strength of a trend, you can never be sure when it
will stop and reverse. Because of this possibility we always want to limit
our risk and look to enter when price is closest to our stop. Since stops are
placed just beyond an inside channel line, the closer we enter to this line
the less risk we take on. It requires patience to wait for a market to come
to you, but the results are much better than chasing after it. There is no
way to avoid losses all together when trading, but there are ways to keep
losses from putting you on the road to the poor house. So keeping losses
to a minimum is a priority. A football team can have a great offense and
rack up score after score, but if the defense can't stop the other team from
scoring more points then they will still lose the game. So the more you
limit what the market is able to take from you, the greater the odds you
will come out the winner.
At times this rule of waiting for the market to trade on your terms will
mean that you will miss out on some very rewarding moves, but a market
that suddenly rockets will also usually burn out very quickly. Figure 1-12
shows how a trend entry is made.
22

34. Channel Sur
fing
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Enter when price is closer to the inside
channel line of an established trend
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Trend entries are an excellent way to start out when first learning to
trade. It follows the well known rule to trade with the trend. You are not
attempting to buy a bottom or sell a top, but instead taking advantage of
a prevailing move. So this entry method is one that you should learn well
because it will serve you well. The negative aspect of this entry is that
markets frequently swing up and down rather than move in a steady trend.
So using just this method will mean that there are fewer trades to take.
It also means that you will miss a good portion of any trend, at least the
initial portion. But the trade-off will be that more of your trades will end
up being successful. It will also go a long way to build up your confidence
and skill. As you skills improve you can add the other methods of entry
that fit your style oftrading. Just bear in mind that with any entry you use,
the key is to always enter when you have the least amount of risk.
So to summarize, the entries are as follows:
1. For a conservative entry, enter when an inside channel line is
broken and price closes beyond that line.
2. For an aggressive entry, enter when the outside channel line is
broken.
3. For an inside entry, enter as soon as your inside channel line
is broken.
4. For a rebound entry, enter after the break of a secondary
channel that returns to kiss the previous channel good-bye.
5. For a trend entry, enter an established trend closest to the
inside channel line.
23

35. A1ichael J Parsons
The following chart examples should help to strengthen yourunderstanding
of these entries. As you review them, look for ways that you can apply
these principles to current markets.
Notiee how the market dropped after
breaking the inside ehannel line
An even better exit is signaled when
priee breaks the outside ehannel line----...
Exiting with this signal
loeks in even more profit
24
Chart

36. Channel Sur
fing
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25

37. Michael J. Parsons
Conse'rvative
Trend Entry
Long from here
Gold
Despite my initial recommendations, eventually you will be faced with the
question as to which entries are best for you. The answer would depend on
your own trading style and the amount of risk you are willing to accept.
Only you can make this decision. You may decide to use all of them or
favor just one or two. There is no right or wrong answer here. But start
by focusing on the two recommended methods of entries and you can
expand later as you become more proficient in using Channel Surfing.
The rebound entry and the trend entry tend to be the most conservative
and least likely to cause confusion. The other entry methods can be added
later as you become more comfortable with the mechanics of how they
develop.
As the expression goes, "the devil is in the details" and so it is true in
trading. There will be many times when you will come across similar
trading set ups where one will have success written all over it while the
other will reek of failure. An inexperienced trader will look at both and
see no difference between the two. An experienced trader will recognize
right away that there is a distinct difference between them even ifhe can't
quite put his finger on what that difference is. The answer will be in the
subtleties that only experience teaches. So take the time needed to gain
experience in using the entries discussed here and it will increase your
odds ofsuccess.
One example where the subtleties will make a substantial difference is
in how you interpret a channel. Remember, the ideal channel will have
two lines that run in parallel to one another, both set at the same angle.
26

38. Channel Sur
fing
But there are times when it is necessary to fan a channel, such as when a
market accelerates. The first and foremost use of fanning is for exiting. It
can be used for entering, but caution needs to be considered when doing
so. You see, there is still likely to be an existing parallel channel line even
ifyou cannot detect it yet.
An invisible channel line can occur with either side ofa channel, but when
it is an inside line it will often become a problem just when the market
seemed like it had already confirmed a reversal. Often, price will just
bounce off this hidden line and resume the prior trend. To "see" where
this channel line is hiding is a simple process of duplicating the outside
channel line and placing it on the inside channel point that is extended
the furthest out of range. This point is usually easy to identify because it
would have been the main culprit in "distorting" the inside channel line
originally. Figure 1-18 shows an example ofa hidden channel l ine.
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Channel Surfing summary
Before I cover any new ground on this subject, it would be appropriate to
review some key points already discussed.
1. Channel Surfing involves the drawing of two trend lines
referred to as channel lines to encompass price movement
either in a trend or in a sideways pattern.
27

39. Michael 1. Parsons
2. A channel l ine is drawn off a series of highs or a series of
lows.
3. The channel line to the right is referred to asan inside channel
line and the channel l ine to the left is referred to as the outside
channel line
4. Channel l ines behave as a fence and direct price in a particular
direction whether this is up, down, or in the case of a trading
range, sideways.
5. Ifeither channel line is broken, than open positions would be
closed.
6. Therearefivemethodsofentryandthey include; conservative,
aggressive, inside, rebound, and trend.
As a reminder, a key component of Channel Surfing is exiting whenever
either channel line is broken. Any open position would be closed or exited
from even if it happens to be the outside channel l ine that was exceeded.
This exit rule would apply to all styles oftrading no matter how aggressive
or conservative the approach may be. Exits can be set up by placing orders
just outside the existing channel lines so that an open position would be
closed if either is reached. When one order is fil led then the remaining
order would then be canceled.
In the case ofan aggressive trader, an entry can be made when an outside
channel l ine is broken as long as the situation implies that a reversal is
imminent and certain requirements are met first. A passively aggressive
trader would enter upon the break of the inside channel line and this is
known as an inside entry. In contrast, a conservative trader would wait
until price bars actually close beyond the inside channel line before
entering. An even more conservative method is the rebound entry which
is signaled by the break of a smaller secondary channel. Finally, a trend
entry would be made after a trend has established itself and within one­
third ofthe trend range, closest to the inside channel.
Before continuing, it would be good to clarify a few aspects related to
developing your own style of trading. Just as a surfer can choose from
among a variety ofsurfboards, beaches and waves, you too have a variety
ofchoices when it comes to the markets and time frames that can be traded.
The choice you make can make the difference between a profitable trade
and a losing one despite the strength of any trading method you possess.
In real life no one is going to buy an Enron when it is clear it's headed for
bankruptcy, so don't trade a dead horse. Slippage will create problems ifyou
28

40. Channel Sur
fing
are trading shrimp so avoid shrimp sized markets. There is no money to be
made ifa stock has stayed at the same exact price for twenty years and looks
to remain that way for the next twenty, so avoid sticks in the mud.
Once you have a decided on a market that suits you, the next choice will be
the time frame that is best for you to trade. This is not a simple decision.
Too large of a time frame and the draw down will be murder. If you do
not have the capital to handle larger time frames, thenjust a couple ofbad
trades wiII deplete your account in a very short period of time. Too small
of a time frame and you will never see a profit. After all, how can you
trade intra-day channels if you only check charts at the end of the day?
Or how can you make any money trading minute by minute if the market
barely moves at that level?
Choose the wrong time frame and your trading will cause you undue
frustration and losses. Your choice of a time frame is not based solely on
your convenience. Just because you may like to trade five minute charts
doesn't mean that you should. There is a balance that will be based on
what a market allows and what fits your comfort level.
For example, many new traders first start out trading daily charts. This can
be an excellent time frame to start with unless the market gaps excessively.
During times of high volatility, a market may be prone to very fast and
wide swings. Trading these swings may require much larger channels
that bring with them much greater risk. A single loss at this extreme size
would be a huge blow to most small traders. But ifyou use too small of a
channel then it can nickel and dime you to death. A proper channel will
allow enough breathing room to allow a market to move while keeping the
draw down tolerable. The benefit of Channel Surfing is that it is flexible
with many choices. If you cannot tolerate larger draw downs then it will
just mean you will have to monitor the market more closely using smaller
channels. Ifyou have a budget that allows more room for draw down then
by using larger channels you have the opportunity for greater profit with
less effort.
It comes down to this; your choice isn't about choosing between the largest
time frame and the smallest that is to your l iking, but a compromise
between the two that fits your trading style, risk tolerance, and patience
while providing clearly defined channels to trade offof. It is more the size
ofthe channel itselfrather than a specific time frame.
29

41. Michael 1. Parsons
In a later chapter we will discuss the use of multiple time frames so that
you can get the best of both worlds. There is a great deal of value in using
multiple time frames, but for now it is important to be able to identify
which channel and time frame is right for you to trade.
Figure 1-19 shows how Channel Surfing can be implemented ill the
different situations that can develop.
What you have seen applied here with this daily chart will work in whatever
time frame you are using. Ifyou were trading intra-day, then you would use
the same exact rules and techniques whether you were looking at a 30-minute
chart or a 5-minute chart. The rules do not change. Trade the same way you
have learned here and keep the rules simple and they will serve you well.
The rest of this book will be devoted to expanding these basic concepts
with advanced techniques that will drastically improve the success ofthis
method. For this reason I would suggest that you hold off trading until
you have had a chance to read what these techniques are. Although it
is true that even without the rest of the book you would have a measure
of success, the difference can be as vast as a beginning surfer trying to
compete with a professional. There is no dispute that the professional will
come out as the winner. Even so, what you have learned so far will serve
you better than most methods that are currently used today to trade the
markets and this will give you a decisive edge. While they are struggling
to keep their heads above water, you will be surfing above them all and
making money, and that is always fun. But then again, surfing always is.
30

42. Chapter TwQ
Breaking Waves
To get the most from a wave a surfer attempts to catch it just as it begins
tobreak. The area where waves start to break is known as the impact zone
and this is where you will see surfers' congregate, waiting for their turn to
catch a wave. Channel Surfing works in a similar way because most ofthe
entries are based on the break of a channel line. But a breaking wave can
at times be hard to predict. While we may already have several choices
for entering a market, all ofthem are based on a clear and distinct channel
that is either fully or partially developed. Unfortunately, some markets
can be very uncooperative about revealing a channels form, making it
very difficult to pinpoint a low risk entry. So a modified entry is necessary
in order to get around this problem.
One case in point involves the early stages of a trend before any channel
is well defined. Price may be breaking higher or lower and giving clear
indications thatthere is a valid trend in there somewhere, but you can't seem
to put your finger on any specific point ofentry until after it has jumped to
a high-risk area. A market that repeatedly gaps and then pauses is a prime
example and can be very tempting to trade because the jumps in price tend
to be very quick and large moves. The problem is that every time it does
pause it just lingers there without any indication of the direction the next
break will be in. This can leave you very nervous about attempting any
trade. So the profit potential is there, but you just don't have the confidence
to trade it. Because a market like this tends to jump so radically, a low risk
entry is essential in case you are wrong about the direction of the market.
What this all boils down to is that you need a simple way of determining
31

43. Michael 1. Parsons
which direction the market is leaning toward before the move jumps into
high gear. Without some sort ofearly entry method you can easily find that
the profit opportunity is all over before you even have a chance to enter.
The way around this is through a few modified rules for Channel Surfing
that focuses on specific situations related to breakouts. A breakout entry
is designed to take advantage ofa modified channel signal. It takes a little
more effort to construct, but is much easier and effective to enter when the
situation calls for it.
Breakout entries are not a new concept. In fact, many trading systems are
totally depended upon them. The theory is that once you exceed a certain
level then the market should continue in the direction of the break for
some time, allowing a person to make a profit. This method has proven
itself many times over. It follows a very simple and basic law of physics;
once an object is set in motion it will continue in motion. Only in this case
we are talking about price.
To be atruebreakout entryprice has to breakoutofsomething. It isn'tenough
to have prices rising or dropping in the normal course ofa trend, but rather
price had in a sense run into a brick wall and then had to develop enough
force to break through. If something has enough force to break through a
brick wall it isn't likely to be stopped anytime soon. So the obvious first step
to finding a breakout trade is to find the proverbial brick wall.
Of course, there are no literal brick walls in the market, but support and
resistance levels behave similarly. Support and resistance levels are simply
price levels that the market reached but couldn't exceed. In essence, they
are horizontal fences that price is likely to bounce off of because it did
so in the past. Find a place where price set a new high or low and then
fell away from it and you have one of these fences. The more times that
price bounces off support or resistance, the more solid that support or
resistance is. It's as if each bounce is another brick that is added to the
wall. So ideally you want to look for levels that price had bounced offof
several times in the past, because once price does break through and holds
it should continue for some while.
Trading range breakouts
An ideal example of this would be a trading range. A trading range
locks price within a high and low boundary. Sometimes they can run for
32

44. Channel Sur
fing
extended periods of time with price continually bouncing from side to
side. But watch out when it finally breaks out ofthat range! Take a look at
figure 2-1 for an example.
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It is important to emphasize here that a trading range involves multiple
hits against the high and low boundaries. One or two do not make for a
solid range and in turn, leave any breakout weak at best. The more hits at
the high and low ranges, the more reliable the breakout is likely to be.
Trading range breakouts tend to be solid trades as long as you allow the
market to confirm the breakout. However, caution needs to be exercised
because even in this situation you will commonly have false breakouts.
False breakouts occur when a market exceeds a level but fails to sustain it.
Instead pricereturns backwithinthezonepriortothebreakout. Fortunately,
there are two reliable ways that a market will confirm a breakout. Either
one can be used as a basis for entering with confidence.
The first confirmation is the close beyond the breakout. For example, if
you break to the upside the previous resistance line should now act as
support. Rather than falling back below this line you should see price
bars closing above it. It is preferred that at least two closes occur beyond
a breakout line before entering a trade; the breakout bar and a secondary
price bar. AdditionaLLy, you should see momentum start to pick up within
a short period oftime away from the breakout leveL. This entry is similar
to the conservative entry that was discussed in the first chapter. Figure 2-2
demonstrates how it works.
33

45. Michael 1. Parsons
SP 500 E·mini 10 minute Chart,......... .n
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The secondary confirmation is a panic bar. This occurs when price exceeds
the range and the price bar explodes like a rocket and never looks back.
Momentum picks up and continues to increase. How far does a bar need
to extend before it is considered a panic bar? There is no exact answer to
this, but the key to determining this is found in the action ofprevious bars.
Look before the trading range and compare the pace that price set within
the market. A panic bar will often extend twice the length as normal and
stand out as significant. A market is also likely to have other examples
of panic bars to compare with, such as when a major reversal occurred.
Markets tend to be prone to panics so it would be unusual to havejust one
showing on any chart. The problem that you can have with panic bars is
that you can place an order early on just as the move gets started and still
not have it filled until it comes to an end, leaving you exposed to higher
risk. Fortunately panic buying usually begets panic buying so it is still
likely to be a solid trade as long as the market doesn't take a break. Beware
ofholding a position based on a panic that extends through a weekend or
holiday. Breaks in trading will take the steam out ofpanics and they will
lose their momentum. Figure 2-3 shows an example ofa panic bar.
The goal of confirmation is to provide some sort of indication that a
breakout is for real and not a trap. Ifa market exceeds a trading range and
then returns back into that range, you are not likely to see it break out in
the same direction again for a while. In fact, a false breakout often signals
that the market will move in the opposite direction. So beware ofany time
you see a market return back within a prior range.
34

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One other factor that adds to a confirmation is an increase in volume or
the number oftrades. We are talking about a substantial increase, notjust
a minor one. Greed and panic should be motivating the market during
these times, resulting in a flock of traders scampering to get in or out. I f
there is no serious increase in the amount oftrades, then the market i s not
responding positively to the breakout and may fail to sustain it and is in
danger offailing.
These confirmation techniques can be used for practically any type of
breakout trade you are considering. There are a number ofpatterns where
you can readily apply them, such as with triangle and wedge patterns. But
some breakout trades will require a more aggressive approach by entering
at the break. Of course, these trades will also include more risk, but the
pay-offcan be more frequent trades and greater rewards. However, it must
be understood that the breakout trades that we are about to discuss are
not of the same caliper as trading range breakouts. There are usually no
multiple hits against support or resistance and you are not likely to see any
substanti.al increase in volume when they break.
Earlier, we discussed an entry based on the break of a secondary channel
called a rebound entry. The signal required a previous break offofa larger
channel before a set up was in place. In effect, the two channels acted as a
form of confirmation because of a repeated break. Now we are returning
to this same basic concept, but with a twist.
35

47. Adichael J Parsons
Mini channel breakout
When a market is unclear about a channel parameter you will often have
instead smaller channels that develop somewhat like stair steps. Obviously,
there is a trend in there somewhere, but it is difficult to put your finger on
its limits. By using a similar approach as we did with the rebound entry
we still have the ability to trade such an obscure trend. The difference here
is that rather than based on the break of a larger channel you are simply
looking for smaller channels to repeat a break in the same direction. So in
a sense this entry is based on what could be referred to as mini-channel
breaks.
The basic concept follows these steps: A market breaks a channel, whether
large or small, and then forms a mini-channel. If the mini-channel breaks
in the same direction as before and continues the trend direction you then
enter at the break. A stop is setjust before the mini-channel zone that was
used to signal the entry. Figure 2-4 demonstrates the technique.
British Pound
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Later. a channel line will
develop that Will replace
the use of mini channels
This method of entry has a higher risk associated with it as part of the
deal, but it does resolve a few scenarios where entering would normally
be a real problem. Just remember, you are looking for a secondary break
in the same direction, one right after the other. If you have a market that
breaks a mini channel in the opposite direction in-between the two then
this approach will not work. To be valid you must have a market stepping
either up or down, not both ways.
36

48. Channel Sur
fing
This entry is particularly valuable when trading a market that frequently
gaps. If you day trade, then you know that this is a real problem when
starting any trading day. When a market opens with a gap because of
overnight trading it frequently attempts to close that gap before doing
anything else. But this is in opposition to the established trend. With no
activity to really base a channel on you could be left out of a good part
of trading while you wait for some parameters to be established. This
method allows you to overcome this lack and enter more quickly.
Using a mini-channel break to enter a market works with another type
of confirmation. Rather than a prior channel break, the next entry simply
uses a prior trend to confirm the mini-channel break's validity.
Throughout any chart you are likely to see trends that pause from time to
time as if they ran out of steam and needed to stop and take a breather. It
isn't that the trend has really finished its run, but simply that it needs to
regroup before going further. These pauses will often form mini-channels.
One of the many examples available is the flag pattern. Flags are short
lived and will often exhibit a tendency to drift in the opposite direction
of the market trend, thereby creating a mini-channel. Usually this mini­
channel will lead to a continuation of the prior trend. Unfortunately, a
trend can also have a dying top where it slowly drifts into a reversal and
will exhibit similar characteristics, so it usually best to wait for the market
to tip its hand before committing to a trade. This tip or signal to enter is
found in the break ofthe mini-channel. Although no prior channel breaks
exist that you would normally use as confirmation, the prior trend itself
serves the same purpose. The only requirement is that both the prior trend
and the mini-channel break be in the same direction. An example can be
seen in figure 2-5.
It doesn't matter whether we are talking about a channel break or a
trend, for a mini-channel break to be valid they must both be in the same
direction. If the market was in an up trend just prior to the flag and then
the flag broke downward, then this would not qualify as a valid signal. It
is possible for such a move to qualify under the normal entry rules, but
that would then depend on a larger channel and the overall trend. Do not
confuse the two methods of entry. Aside from this and the added risk,
you will certainly find plenty ofopportunity to use mini-channels in your
trading. They frequently show up within any market providing some great
trading opportunities.
37

49. Michael 1. Parsons
��DesPite having different angles, each of these
t/ are flags and can be used to signal an entry
Corn Chart
Trading false breakouts
In real life, trading a breakout is not always as simple as we would hope.
There are a host of reasons why a market may muster enough strength
to break through a wall and still falter and return to the prior side of that
wall. A failure is referred to as a false breakout, a term that is very fitting.
Synonyms for the word false include terms such as misleading, deceptive,
wrong, fabricated and deceitful. All ofthem apply well in describing what
a false breakout means for a trader. This is why there is a need to look for
confirmation on any breakout trade you are considering. Unfortunately,
false breakouts are a frequent occurrence and are very effective in trapping
traders on the wrong side of a trade.
So what do you do ifyou entered a trade only to discover that it wasjust a
false breakout? The first step is to get out ofyour trade as soon as possible.
As simple as this statement may seem to be, when dealing with breakout
trades this is an extremely important point to understand. False breakouts
have a nasty habit ofmoving in the opposite direction and sometimes this
turns out to be a considerable move. In other words, if you bought on a
breakout to the upside and it turned out to be a false, then price may not
only drop back within the pre-breakout zone but continue to fall much
lower. If you failed to exit at the first sign of trouble you could be looking
at a substantial loss.
38

50. Channel Sur
fing
Despite the prevalence of false breakouts, there are times when a market
will seem to fail to follow through and drift back into the previous
zone, only to reestablish a channel that carries it back in the direction
of the original breakout and beyond. So a return to a prior zone does not
guarantee that your trade has gone wrong. A saving grace will often be the
channel that forms just before a breakout occurs and this can be used to
judge the progress ofany breakout. If this channel holds despite returning
within the prior zone then there is a possibility of a successful trade. If it
fails then the odds of success dramatically drop with it and you need to
exit. An example ofa channel that brings a false breakout back to life can
be seen in figure 2-6.
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the breakout fails to hold
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So a failure can still become a success as long as a channel manages to
hold. Even if it did turn out to be a bad trade, you may still be able to take
advantage ofthe signal in another way. A failure has the tendency to carry
a market a considerable distance in the opposite direction, so reversing
your position can turn out to be a very profitable trade. This is particularly
true when it involved a break ofa major brick wall ofsupport or resistance
and failed to follow through. Remember, if it took a considerable amount
offorce to break through it once, it takes a similar force to break through it
a second time. In essence, it is a breakout trade that breaks out again, only
this time in the opposite direction. Don't take this move lightly because
the market will not. It is the nature ofthe market to implode on itselfwhen
there is a failure and this tendency offers one more opportunity for profit
from a breakout or in this case, a failed breakout.
39

51. Michael 1. Parsons
False breakouts have an added force hidden within them. It is called limit
orders and they can be found sitting at predictable levels within a market,
especially just beyond breakouts. Traders who themselves are trying to
take advantage of a breakout trade as a market hits new levels will place
standing limit orders just beyond the breakout. As I mentioned earlier,
breakouttrades are nothing new and usedquite frequently by othermethods
of trading. So as price hits these levels a flood oforders is activated. This
initially adds strength to the conclusion that a breakout is valid, so often
others will jump on board as well. But if this demand is not enough to
sustain the move then the market quickly returns back into its previous
zone. Now all these traders who had their limit orders activated have a
problem, they are sitting on the wrong side ofthe market and in a loss. So
many of them start to scramble to get out ofthe trade and this pushes the
market further away from the original breakout, fueling even more orders.
As fear picks up, the market is often pushed beyond any range that was
established and panic ensues, driving the market even further away.
So if you can correctly identify that a false breakout is occurring early
enough then you are in a prime position to make a very nice profit. The
key to this trade is to expect certain requirements to be met. Otherwise
the move will tend to be very weak. The main requirement boils down to
whether the breakout was a substantial one or not. There are two ways a
breakout will establish itself as significant before it occurs and if either
are present then it would certainly qualify for reversing positions when a
failure does happen.
Repeated attempts at breaking through a barrier would certainly qualify.
This is in essence what happens with a trading range. So a well defined
trading range where a failed breakout occurs is an example of a good
candidate.
The second way would be when the market set a prior high or low and
significant time has passed before attempting to break it again. In this
instance, it is the time factorthat makes it significant. It took a considerable
effort for the market to return to that same level again. Ifprice now breaks
this high or low but still fails to sustain it, the market will likely react by
moving in the opposite direction, just as it did before.
This second version can seem a little difficult to interpret. The question
that invariably arises here is; how much time is considered enough of
a time elapse between a prior high/low and the one that breaks it? The
answer is simply; enough time to establish that any break is a serious
40

52. Channel Sur
fing
accomplishment by the market. This is usually a judgment call based on
how the market develops, but it can be based on a more restrictive and
defined rule such as a set period oftime.
For example, you could require that any breakout failure be at least twenty
days from the prior high or low it exceeds before considering a trade. This
way, there are no questions as to whether enough time has passed. Some
trading methods use this exact same rule. But this is only a hypothetical
rule and what you use should be in line with how a particular market has
responded to false breakouts in the past. The important issue is that the
high or low stand out so that any break will catch the interest of other
traders. It is additional traders that fuel these moves. If it isn't a breakout
that stands out in your mind, odds are it will not be outstanding to others
who are trading the market. Ifyou see it as significant, odds are that others
will too. Figure 2-7 demonstrates how significant this can be.
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Breakout entries have their inherent risks, but utilizing these set ups can
also provide a wealth of profitable trading opportunities. At times you
may even find yourselfdependant on them to make a large portion ofyour
trades. Some markets are best traded using breakout entries while others
will tend to slap anyone that tries to trade this way. It will take some
perception on your part to know which the market you are trading favors.
In any case, it is important to realize that breakout entries are simply an
addition to the original Channel Surfing rules and not a replacement. Any
market you are trading still requires you to establish the parameters and
risk as best as you can before even considering a trade. It also pays to be
41

53. Afichael J Parsons
nimble, particularly if any sign of trouble exists. Breakouts tend to move
very fast, even if they fail. But on a positive note, breakouts tend to work
out well in a large percentage oftrades. So don't forget to use this entry as
you become more proficient in using Channel Surfing. Just set up in the
impact zone and hit those breakers!
42

54. Chapter Three
Kiss of the Channel Line
While the title of this chapter may conjure up thoughts of a romantic
interlude while surfing channels, the kiss of the channel line has nothing
to do with us personally. The love ofits life is price and understanding the
choreography between the two elements allows us to exploit the attraction
between the two for profit, not love.
There is a lesson to be learned here from a movie entitled "Kiss of the
Spider Woman". Technically, it was a movie about two prisoners and how
one uses a Nazi propaganda movie he once saw about the unlikely love
affair between a French chanteuse caught up in the Resistance and the
chief of German counter-intelligence for occupied France to manipulate
a fellow prisoner into accepting a homosexual relationship that he would
otherwise have viewed as repulsive. In the end he succeeds.
So the movie is really about the process of weaving a web of emotion
around an extreme point ofview in order to manipulate a person to accept
it, even though he would normally be repelled by such an action. The lesson
here is a psychological one, having to do with taking one relationship and
using it to manipulate another. So it is true when it comes to learning how
to trade. We have to take certain aspects ofthe relationship between price
and channels and weave them together in order to extract a profit. As in
this movie, you are in essence playing off the psychological extremes of
other traders while they are manipulated into accepting what they would
normally be repelled by, taking a loss.
43

55. Michael 1. Parsons
The point here is that while Channel Surfing is a technical trading
method, its success is rooted in crowd psychology. It is important that you
understand this concept because the market is designed to play on one's
emotions and does so in extremes. Emotionally you want to sell when
you need to buy and buy when you need to sell. For most, emotion will
overrule logic. Our heart can make even the most foolish act look like a
good idea. Ask anyone who has fallen in love with the wrong person and
they will agree. This is why understanding what makes channels tick and
how markets really operate is so very important. Otherwise, you we will
be caught up in the emotional roller coaster that will have you manipulated
into doing what you would never want to do, take a loss.
Here lies one of the hardest lessons for traders to learn; despite all that
you learn the market will still find ways to have you doing what it wants
you to do. It is for this reason that some people will never succeed in
trading. When the market starts rocketing higher, it screams at you to
buy as greed takes hold. The temptation becomes unbearable and you can
hardly restrain yourself, but restrain yourself you must because the turn­
around is imminent. Or immediately after you have bought price spikes
lower and fear grabs hold ofyou. Seconds seem to last hours as panic sets
in. The market screams at you to sell and you can hardly contain yourself,
but contain yourself you must because as soon as you exit you do so at a
loss and usually just before the market finally moves your way. All the
profit that would have been made has passed you by.
Can you fight and control these emotions? There is absolutely no avoiding
them. You will have to face this battle and only you can conquer them. If
you cannot do so, then nothing in this book or any other will help you to
trade successfully. Fear and greed will warp your senses into believing
you see things that are simply not there. Only by detaching yourself
emotionally from your trading will you be able to trade logically and
perceive what is really happening. A market is a living organism with a
will and personality of its own. Like a wild animal it cannot be trusted.
But it can be managed, at least in regard to specific situations. However,
even in controlled situations you cannot let your guard down, particularly
when you are dealing with a predator that will chew you up and spit you
out. Our greatest vulnerability to this beast is our emotions. Many forms
of spider venom attack the nervous system, rendering a victim helpless
and unable to move. The market's venom also attacks the nervous system,
but instead causes erratic and uncontrollable movement. Beware the kiss
ofthe spider.
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56. Channel Sur
fing
Despite this reality, the way a market unfolds with channels and their
subsequent dividing lines is a beautiful process to behold. The intricate
design of these lines will often literally reflect that of a spider web. But
if we have a spider web then we have a spider. For most small creatures
being caught in a spider's web means a death sentence. For man, the kiss
ofthe spider is a painful one, but that has not prevented man from profiting
from the use of spider webs as well. For example, primitive people in
New Guinea have used spider webs as fishing nets, while others have
used spider webs to make clothing and thread. The difference is in who is
exploiting the web, the spider or man.
In order to exploit the web the user has to understand it. The same is true
in regard to the markets. But while a web is designed to remain stable,
markets are not. They are ever changing like that ofan ocean. Yet, even an
ocean has a "web" ofinterconnectedIimits that it weaves throughout itself.
Understanding how those limits are set will increase your understanding
of how a market weaves its own web as well.
Despite appearing chaotic, the waves ofan ocean are still built upon the
laws ofphysics. Obviously, an ocean is not built in the same manner as you
would build a house. A bouse is rigid and unchangeable, an ocean is not.
But an ocean is subject to some very specific limitations, making certain
actions predictable. A wave will not raise above its shoreline limits, only
an additional influence such as a storm or tidal wave can do this. It has to
instead settle on a very narrow range of shoreline determined by the tide
and wave strength. Additionally, a wave will not break in the direction
away from the shoreline. It must always break toward the shore and do
so continually. These simple limitations enable a surfer to take advantage
ofan ocean and its waves. Still, a few limitations are not enough to allow
a surfer to surf. A surfer also needs to understand the subtleties of how
these limitations work. There are no surfers out on their boards using a
slide rule or calculator. They use their experience and knowledge to judge
what will unfold.
So too, more is needed than just simple rules to trade successfully. One
also needs to understand the how and why. Perception is a required skill
in this business. Just consider a few ofthe rules that we bave covered so
far and you will find that in real life applications there are a few situations
where they appear confusing and even contradictory. The rules are solid,
but you have to apply them to something that is not. Markets are ever
changing and require greater perception than any simple entry and exit
rules can provide.
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