Trading High Probability Consolidations

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Trading High Probability Consolidations

March 17 offered a number of consolidations in the EURUSD during the US session. Certain types of consolidations provide ideal trade candidates, as risk can be kept very small and the relative reward can be huge (trading traditional markets). If trading binary options these consolidations can still provide great trade opportunities, but you’ll need to flip through some historical charts to determine how long the high probability consolidations last so you choose an appropriate expiry. Here’s the basic setup we are looking for…as well as some examples of what we aren’t looking for.

High Probability Consolidations

First off, “high probability” is somewhat subjective, since we are looking for consolidations that have a general appearance, and it will take some practice to spot them.

In Trading the Mini-Channel Breakout I discussed a very tight pullback or consolidation, where the price typically moves in a very small channel against the trend. Today, we look at another slight variation of that.

After a nice trend it is common to see the price “drift” either sideways or slightly against the trend. It may not exactly be a channel, but there is little directional movement, the price is wiggling back and forth within a small area (relative to trend) and most importantly price isn’t showing any aggressive movement against the trend to indicate the trend is over. When this occurs, we have a great setup.

The oval in Figure 1 marks this type this of consolidation. The trend is up, and then the price begins to drift sideways. In hindsight, I can circle the whole consolidation, but in real-time you wouldn’t be able to tell the price is moving sideways until several waves have formed and the price is no longer moving to the downside.

Figure 1. High Probability Consolidation – EURUSD 1 Minute Chart

The majority of the consolidation is less than the half the size of the last thrust higher; if the consolidations becomes bigger than this then the probability of the consolidation declines because it may be a topping or bottoming (during a downtrend) pattern.

High Probability of What?

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A consolidation is a pause in a trend, therefore, in figure 1 we want to buy during that consolidation because we can anticipate that the trend will continue following the completion of the consolidation.

It does not work all the time, and it does take practice to spot high probability consolidations, but more often than not when I spot these consolidations the trend resumes after.

A “classic” approach to consolidations is to wait for a breakout. In Figure 1 that would mean buying near the top of the oval or even slightly higher.

When we have a consolidation that looks like this I know that more often than not the trend will continue. Therefore, I do not wait for a breakout. I try to buy near the lows of the consolidation (for an uptrend like in Figure 1) and then just hold it until an upside breakout actually occurs. I place a stop a bit below the consolidation.

If the price ends up breakout lower, since I bought near the low of the consolidation (in an uptrend) and my stop loss is nearby, my risk is extremely small. On the other hand, if the price breaks higher, which often it will, I have one of the best prices and can maximize my profit.

Figure 2. Entry and Stop

In figure 1 I marked the point where in “real-time” we could anticipate that this was a tradable consolidation. After that point we could put out an entry in the lower portion (in uptrend) of the consolidation. A stop is placed a bit outside the consolidation.

If the trend is down, we look for a similar looking consolidation, but we will enter a short position (buy puts) near the top of the consolidation, expecting the price to trend lower once the consolidation is over.

If using a profit target, Fibonacci Extensions can help approximate where to take profit.

What We Aren’t Looking For

Later in the US session, on March 17, we see another consolidation. Yet this is not the same as the prior consolidation. So while I would trade Figure 2 as shown, I would not trade the consolidation shown in figure 3 the same way. The chart explains several reasons why, although mainly the pattern is more volatile–it isn’t “drifting” and that means it is harder to control risk and could quite possibly be a reversal pattern instead of a consolidation where we are expecting the trend to continue.

Figure 3. Don’t Trade This Type of Pattern the Same Way – EURUSD 1 Minute Chart

When there is a nice trend and then the price begins to drift sideways, or even slightly against the trend, I get aggressive. Once I realize the price is consolidating, I want to get in near the low of the consolidation during an uptrend, or near the high of the consolidation during a downtrend. This keeps my risk very small and my potential profit large. It takes practice to spot these types of consolidations though. Utilize it in a demo account, spotting the patterns, entering and exiting/choosing expiries. Until consistently profitable with method don’t trade it with real capital.

Trading High Probability Consolidations

Chart = Consolidation In A Triangle

Generally when traders refer to consolidation trading , they only think of the horizontal channel consolidation . However, there are various types of consolidations . Really, one can quickly improve the consolidation trading as soon as one begins to make use of various types of consolidation patterns .

Types Of Consolidation Trading

1/ Consolidation During A Rising Channel
That occurs when a financial instrument is oscillating around a bullish dynamic trend line as it is rising without deviating too far away from it. The median in this case is called dynamic trend line.

2/ Consolidation During A Declining Channel
That occurs when a financial instrument is oscillating around a bearish dynamic trend line as it is declining without deviating too far away from it.

3/ Consolidation During A Triangle Chart Pattern
A triangle is a type of consolidation . It does not matter whether it is one of the following:
a/ ascending triangle,
b/ descending triangle,
c/ symmetrical triangle,
d/ expanding triangle
e/ ABCDE Elliott wave triangle
f/ Or any other types of triangles.

4/ The horizontal Channel Consolidation

The most popular consolidation is the horizontal channel.
This time, the price is consolidating around two horizontal key levels. A resistance that is above the price’s range and a support at the other end. Generally, at the sound of the word consolidation, many technical traders only think of the horizontal consolidation . Note that the horizontal consolidation is also called a balanced market pattern when one is talking about market profile .

During a trending phase, there are pauses in the form of various types of consolidation . However, the horizontal consolidation often precedes trending phases in the financial markets. Traders refer to a consolidation phase before a bullish trend as an accumulation, but the consolidation that precedes a bearish trend is called distribution.

Usually, the volatility is low during the consolidation , but there are times when one may come across high volatility consolidations .

5/ Combination Of Different Types Of Consolidations

For example, one may recognize a triangle within a normal consolidation or a smaller triangle in a wider triangle or another consolidation that is inside a dynamic consolidation .
Truly, as one begins to gain more experience as a technical trader, one will be able to pinpoint a wide varieties of consolidation market patterns .
One can just start highlighting the consolidations one by one.
Taking each pattern apart before looking for the next one until one could not isolate any more consolidations .

6/ Fractal Consolidations Trading

Fractal consolidations are those that duplicate their structures on various times frame. They are predictive consolidation patterns that can help advanced technical traders to forecast the next price-action.
Those consolidations may also copy and paste (duplicate) their structures
at different stages on the same time frame or from one financial instrument to another (financial instruments that belong to the same sector or index).

Understanding Consolidation Price Structures

Financial instruments consolidate around influential key levels.
When one identifies a consolidation , one must highlight the median line.
Moreover, one can highlight those median lines like the market profile traders, and
select the best trading set-ups around them.

Many times, a financial instrument will rise from one median line to the next and vice versa.
In fact, those median lines become more influential if the price did not revisit them since they are in place. Market profile traders wait for high probability trading set-ups near those virgin median lines.
A consolidation is also called balanced market because in theory there is an equal influence between the bullish and bearish traders. That equal influence or force causes the price to oscillate around a median price level. Truly, the bulls cause the price to rise up to a distance, but the bears quickly sell it, and it goes back to the initial point. One can say that the price is not going anywhere as long as there is a balanced market (or consolidation ).

A technical traders must learn how to recognise and trade the different types of consolidations in any financial markets. One will also begin to improve technical trading as one aligns the appropriate trading strategy with each
consolidation pattern . As I always say to traders, the market pattern will determine the appropriate trading strategy one will be deploying. Use the various consolidations to positively impact your technical day and swing trading today.

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