Making use of consolidation patterns by Darren Winters
Almost every time a stock makes a move higher or lower, at some point it will stop and consolidate. A consolidation occours as investors digest the recent price movement and contemplate whether to sell or buy as these noew prices. It is only when enough investors (volume) make a collective decision that the stock will move once more.
Consolidations come in various guises and are well worth learning about. We constantly use them for our analysis in the weekly update where we are looking for shorter term movements. Consolidations occur in all time frames, from a one minute chart, up to a monthly chart. If you are a regular investor who likes to hold a position for several days or longer, you should be keeping an eye on the 15 minute, hourly and daily charts.
You can see some very clear consolidations vuild on a 15 minute and houlry chart that are not evident on the daily time frame. For this reason, having access to intraday charting software is important.
I have drawn a number of consolidating patterns that we frequently see in the markets. Firstly, at the top, I have drawn a rectangle. In an uptrend, this is deemed to be a bullish pattern and in a downtrend, it is bearish. Like most consolidations, we usually wait for the breakout of the pattern before making a trade.
Once a pattern has started to form, it is useful to place some trend lines on the support and resistance areas so the you can define possible breakout points. For a rectangle, it is very obvious where the breakout points will be. We would look for a move on increasing volume in order for us to enter a trade.
The next chart is a flag pattern. In an uptrend, these are considered bullish vice versa. Bullish flags like the one shown are characterized with lower tops and lower bottoms, with the pattern slanting against the trend.
The final chart is a bullish pennant where the tops are getting lower and the bottoms are getting higher. In this situation, we would look for a convincing break out of the pattern to give us our trade.
It is worth noting that rectangle can last for a considerable period, but flags and pennants tend to last a much shorter period relative to the time-frame you are looking at.
EXAMPLE
The following examples on a daily chart of the S&P are clear flag patterns. When you look at smaller time frames you will notice consolidations forming even more frequently.
It is worth noting that youy should not religiously look for the patterns shown on this page. There are many more consolidation and continuation patterns that can be seen on the chart. ALso, just because a stock is n0t making a perfect patterns, it does not mean it is not consolidation. Any period of congestion after a large move is basically a consolidation.
The basic premise is that if a stock moves higher and the consolidates near the highs, the chances are it is building for another move higher. The alternative is true on the downside.
TAKING ADVANTAGE OF THEM
Personally, I like to wait for a breakout of a consolidation to occur before I enter a trade. I can do this by one of two ways. Firstly, by setting price alters with my onlime broker to notify me if a stock breaks through a key area. I would then go in and place a trade after assessing supporting volume and other indicators.
Alternatively, I could plave stop orders to automatically enter me into a position should these be triggered. It is probably best to start off by setting price alerts and then manually placing a trade when the break has taken place.
Some option speculators, including ourselves on occasion will place straddles to take advantage of the impending move. These have to be entered before any breakout had taken place and I would suggest you read out back issues to learn more about these.
If you have a charting package, it is well worth spending some time looking at consolidations as they can produce some excellent profitable trades.
Even as I write this, there is a lovely consolidation on the 30 minute chart of the Dow. Looks like a trade needs to be placed!
Darren Winters
Consolidations come in various guises and are well worth learning about. We constantly use them for our analysis in the weekly update where we are looking for shorter term movements. Consolidations occur in all time frames, from a one minute chart, up to a monthly chart. If you are a regular investor who likes to hold a position for several days or longer, you should be keeping an eye on the 15 minute, hourly and daily charts.
You can see some very clear consolidations vuild on a 15 minute and houlry chart that are not evident on the daily time frame. For this reason, having access to intraday charting software is important.
I have drawn a number of consolidating patterns that we frequently see in the markets. Firstly, at the top, I have drawn a rectangle. In an uptrend, this is deemed to be a bullish pattern and in a downtrend, it is bearish. Like most consolidations, we usually wait for the breakout of the pattern before making a trade.
Once a pattern has started to form, it is useful to place some trend lines on the support and resistance areas so the you can define possible breakout points. For a rectangle, it is very obvious where the breakout points will be. We would look for a move on increasing volume in order for us to enter a trade.
The next chart is a flag pattern. In an uptrend, these are considered bullish vice versa. Bullish flags like the one shown are characterized with lower tops and lower bottoms, with the pattern slanting against the trend.
The final chart is a bullish pennant where the tops are getting lower and the bottoms are getting higher. In this situation, we would look for a convincing break out of the pattern to give us our trade.
It is worth noting that rectangle can last for a considerable period, but flags and pennants tend to last a much shorter period relative to the time-frame you are looking at.
EXAMPLE
The following examples on a daily chart of the S&P are clear flag patterns. When you look at smaller time frames you will notice consolidations forming even more frequently.
It is worth noting that youy should not religiously look for the patterns shown on this page. There are many more consolidation and continuation patterns that can be seen on the chart. ALso, just because a stock is n0t making a perfect patterns, it does not mean it is not consolidation. Any period of congestion after a large move is basically a consolidation.
The basic premise is that if a stock moves higher and the consolidates near the highs, the chances are it is building for another move higher. The alternative is true on the downside.
TAKING ADVANTAGE OF THEM
Personally, I like to wait for a breakout of a consolidation to occur before I enter a trade. I can do this by one of two ways. Firstly, by setting price alters with my onlime broker to notify me if a stock breaks through a key area. I would then go in and place a trade after assessing supporting volume and other indicators.
Alternatively, I could plave stop orders to automatically enter me into a position should these be triggered. It is probably best to start off by setting price alerts and then manually placing a trade when the break has taken place.
Some option speculators, including ourselves on occasion will place straddles to take advantage of the impending move. These have to be entered before any breakout had taken place and I would suggest you read out back issues to learn more about these.
If you have a charting package, it is well worth spending some time looking at consolidations as they can produce some excellent profitable trades.
Even as I write this, there is a lovely consolidation on the 30 minute chart of the Dow. Looks like a trade needs to be placed!
Darren Winters
posted by Darren Winters at 11:51 AM
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