What is Consolidation Channel?
In technical analysis, the movement of an asset’s price within a well-defined pattern or barrier of trading levels. Consolidation channels are generally regarded as a period of indecision, which ends when the price of the asset breaks beyond the restrictive barriers.
Periods of consolidation can be found in charts covering any time interval (i.e. hours, days, etc.), and these periods can last for minutes, days, months or even years. Lengthy periods of consolidation are often known as a base.
The levels of resistance and support within the consolidation are created through the upper and lower bounds of the stock’s price. Once the price of the asset breaks through the identified areas of support or resistance, volatility quickly increases and so does the opportunity for short-term traders to generate a profit.
In forex trading, the candlestick pattern known as consolidation occurs when a trend loses momentum. Sometimes momentum is lost due to profit taking when traders exit the market to lock in their winnings. In this case, when action resumes, the trend is likely to continue in the same direction as before, as traders re-enter the market for further profits.
However, at other times momentum is lost when a trend is affected by an economic announcement or simply runs out of steam. In such a case when forex trading picks up energy again, the trend may reverse direction, sometimes abruptly, and traders who miss the reversal signals, at the very least, will miss the boat.
Sideways trends can be found inside support and resistance levels that are near each other. Inside the Forex trading trend line the currency price still fluctuates, but with rather small ups and downs. A sideways trend is said to be broken when the currency price goes outside the previous limitations of the trend line. You might like to make sure that the price goes outside the barrier of the trend line twice before being sure the sideways trend is broken.
What does Consolidation Channel do?
Much like the first dynamite compound invented by Swedish chemist and engineer Alfred Nobel, consolidation periods and patterns in the currency markets can explode, leading to great profit opportunities for the FX trader. Consolidation periods do suggest the indecision in the market, which is great for capturing potential gains because the burst of directional action that follows can last for an extended period.
Understanding and trading on consolidation patterns will give the currency trader in the know two edges. First, the trader can hold his or her initial position for a shorter amount of time, thus minimizing the risk of holding positions in the case of higher rollover interest. Second, the profit potential from such a position can be big, as long as the trader follows strict, disciplined money management rules. Without money management, the trader might as well be playing with fire.
How do I trade Consolidation Channel?
Most people enter into a trade when prices break out of the highest price (or lowest price) of the consolidation. If prices break upwards, they buy. If prices break downwards, they sell. The decision to trade on breakouts is based on the assumption that the momentum of the break will be strong enough to push price further in the same directions.
Breakout trading can yield rather consistent profits. This is because they usually follow through. The hard part is deciding when to exit your trade once its in-the-money because breakouts sometimes reverse directions quite quickly.