Trading Price Consolidation: The Lull Before the Storm

[tmbaru 10]

Introduction

Market volatility just like the emergence of price patterns in different time periods can open up an ocean of opportunities for the Forex trader. Just like explosions, they may scare other traders but the daring will remain to reap bountifully. The question thus comes-how prepared are you as a trader to cash in on these opportunities? It is a mantra that has transverse space and time that a lull comes before a storm. In the Forex markets, this holds true as price consolidation periods are considered a periods of low volume and indecisiveness on the part of market traders. What most traders may not be aware however is that this is a period of strategy formulation and forecasting. This is because the thereafter the prices may burst into paths that will take long to weaken and reverse.

 

The two-edged sword

A thorough knowledge of price consolidation is of paramount importance. A trader honed with price consolidation knowledge will have two main advantages in trading. It gives the trader the ability to take a short position to minimize likely losses following a bounce towards higher interest.

 

The second platform of advantage for such a trader lies in the money making or profit position. Coupled with an established money management discipline, a trader may reap handsomely from price consolidation as profits potentials are high in such positions.

 

Consolidation patterns and how to trade in them

There are number of price consolidation patterns in the market and learning how to trade in them can be a great investment on the part of the trader. The discussion that follows captures two basic patterns and how one can effectively initiate trades without exposing themselves to unnecessary losses. These price consolidation patterns can be split into two categories; reversal patterns and continuation patterns.

 

Continuation patterns continue the direction of the trend after consolidation while reversal patterns have a likelihood of reversing the trend after price consolidation.

 

Flags

These are continuation patterns. They form some of the dependable patterns and are common in explosive price movements. Flags in uptrend are bullish in nature referred to as Bull flags while in downtrends they are called Bear flags. They basically continue the existing trend. The price consolidation under bull flags is characterized by short lower tops and bottoms while under bear flags it is identified by short series of higher lows and higher highs. During the price consolidation period, volume normally flattens out.

 

Trading the flag pattern

To trade this pattern a trader must employ the use of trend lines to map the flag formation. The support and resistance levels are identified first. After the mapping of the trade channel, the points where the price movement tends towards either the support or resistance levels are marked clearly.

 

As a cautious measure, it is prudent that a stop loss order be placed 66.7 percentage points below the previous sessions high so as to contain the trend should the price dip below the resistance level.

 

It is also advisable to trade short; hold the security for a day. In anticipation of further gains, other traders also hold for longer periods but it all depends on the risk appetite.

 

Wedges

A wedge is a dual consolidation pattern. It can be a reversal as well as a continuation pattern. A falling wedge in both uptrend downtrends can be bullish. Volume diminishes during the consolidation period but then increase later on.

Rising wedge on the other hand is bearish in both uptrend and downtrend. Like in the falling wedge, volume diminishes as consolidation is reached.

 

Trading wedges

The minimum estimated or forecasted profit target can be calculated by measuring the bottom of the wedge commonly referred to as the base.

 

The ‘pole-like ‘move can also be used to measure the minimum profit target. This is done by identifying a pole- like move (the sharp price the formed the move). The bottom of the pole (beginning price) and top of the pole are measured. This is what is termed as the measured move.

 

For a trader who is entering the market, he can move through to the last point which will serve as the failure and exit point. Movement through the apex can also be chosen as a failure and exit point.

 

A trader should closely monitor volume changes as a chart pattern failing on an upsurge in volume could increase the probability of a price movement towards that direction.

There are traders who get in before a break out occurs. In such a case as a trader, move through the ‘wrong side’ of the pattern using it as your failure and exit point.

To help minimize losses and exit at the right time, monitor the volume movement as it can give indications of either a bullish or bearish run.

 

The beauty with these trading strategies is that they can be applied by both amateurs and experts alike. Remember to apply both reversal and continuation patterns as the outburst direction may not be easily predictable.