Trading in consolidation pattern can result in a substantial profit, but you need a comprehensive understanding of consolidation to trade in it successfully.
When a market trend is continuously moving upward or downward, it becomes increasingly vulnerable to a reversal. A consolidation or a momentary pause in the ongoing trend confirms that the trend continues in the same direction. When consolidation happens, it gives traders opportunities to enter a new position or add to the existing.
Consolidation happens when the market is moving sideways. Now we have to see how to interpret consolidation to form a solid trading strategy around it. Depending on where they are occurring in the price chart, consolidation candlestick patterns indicate trend continuation or reversal.
Before we discuss the various consolidation candlestick patterns, let’s understand consolidation in market parlance.
What Is A Consolidation?
Consolidation represents moments of indecision in the market before it corrects itself.
Looking out for consolidation patterns is one way to determine when the market trend might change. When traders look for consolidation candlesticks, they do it to enter a new position or to strengthen the existing.Either way, understanding consolidation candlesticks are crucial if you want to form robust trading strategies.
Most of the time market moves sideways, and the consolidation candlestick patterns occur during this phase. When it appears, consolidation patterns either indicate a trend continuation or beginning of a new trend.
All consolidation indicates a momentary pause before the next price move when the traders adjust their expectations.
Let’s study the consolidation patterns. There are quite a few of them, and we will briefly review them each before discussing how to trade around them.
Consolidation Candlestick Formations
We are going to take a look at sideways patterns, upward and downward sloping ranges, and triangular patterns. Let’s take a look at the different pattern formations.
Most of the time the price moves within a range in the market, with occasional breakouts. A range refers to a formation of price candlesticks that oscillates around an average price. It is a moment the market forms an agreement regarding stock price.
A range can form in upward or downward trends, as well as when the market is moving sideways, coupled with false breakouts occurring at both top and the bottom. The best way to trade in a range is to wait for confirmation.
Range formation reveals useful trade information regarding planning an entry in the market.
The symmetric triangle pattern is a common formation with a slightly sloping upper boundary (resistance line) and an upward-moving support line. The range has a wide opening but contracts at the end, making the range look like a triangle. A breakout usually happens before the resistance and support line converge. Traders estimate a profit target by studying the differences between the first relative high and first relative low, then adding it to the breakout point when the trend is upward. Similarly, they calculate a profit target by subtracting the difference from the breakout when the market trend is downward.
An Ascending Triangle
In the ascending triangle formation, the price bounces between the horizontal resistance line and an upward sloping support line revealing growing impatience among traders to break the resistance line for a particular stock. It appears when there is a strong demand in the market for an underlier.
The converging trianglepattern appearing within an existing uptrend is more reliable for stocks which are already trending.
Descending triangle pattern is the opposite of the ascending pattern, appearing in the downtrend. A declining resistance line represents the upper limit of the price triangle when a horizontal support line creates the base, between which the price moves for a while before a breakout.It appears when traders are overwhelmingly bearish about an underlying.
A descending triangle appearing within an existing downtrend is more reliable, and usually, the stock price hits a new low (breakout) before the two lines converge. Traders set a profit target after subtracting the difference between the relative high and low from the lower boundary of the lower breakout.
Rectangle or Flag Pattern
A rectangle is just another consolidation pattern with resistance and support line as respective upper and lower boundaries. It is called flag because it appears after a long candle or pole. Price continues to bounce off between the two lines for a while before breaking off to resume the previous trend.
The appearance of a flag warrants attention because these are usually high risk-reward situations. A flag usually follows a strong trend, sharp advance or decline supported by strong movement in volume.
Consolidation Trading Strategy
Trading in consolidation can result in big rewards. These are momentary pause before a big jump in the market trend. Traders usually look at the following three aspects while trading in consolidation.
Volume: Following volume movement gives subtle clues about the strength of the consolidation. Usually, volume remains low or flat during the consolidation phase and picks up right at the end before a potential breakout.
The size of the consolidation: The size of the consolidation indicates pressure building for a breakout. A longer period and narrower boundaries usually result in a robust breakout. However, traders must stay aware that it also increases chances for a false breakout. During long consolidation phases, one must act with caution and wait patiently for a real breakout before entering.
Reset Confirmation:After a breakout, an underlier may fall back to the consolidation phase during a period of reaffirmation. It is a common occurrence in foreign currency trading but can happen for any type of underlier.
Consolidation begins with indecision regarding an underlier’s price but ends with market consensus. Technical analysts study consolidation with the help of candlestick patterns to understand the next market move. A trader who is first to spot a consolidation pattern usually makes the most profit, but it also means he exposes himself to greater risk. Studying consolidation candlestick patterns gives an advantage of successfully spotting a trading opportunity by identifying an exact moment to buy.