During a consolidation period, prices oscillate between a small range as supports comes in to prop up falling prices and resistances become formidable barriers to force prices to fall back to support levels. This type of trading action forms an easily identifiable pattern called a “channel” or “rectangle”. How should a trader trade during consolidation or congestion phases?In this article Peter Lim explains how one can trade the consolidation phase.
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When stock prices start to move within a certain range, falling to established lows and then rebounding up to established highs and fall back again, the stocks are said to be in a consolidation or congested phase.
Most of the time, typical consolidation patterns can be seen, with the most common one being the rectangle pattern or sometimes called a price “corridor” or channel.
When prices start to drop, traders get nervous and weak holders will sell their stocks so that they will fall to a support level which other traders will consider a good price to buy. From that level, stock prices will then rebound, often with volume as support comes into the stock.
As the price of the stock improves and increases, it will reach a peak where traders who have purchased the stock at lower prices will sell. At the same time, weak holders who have purchased the stock at higher prices may wish to bail out as their losses are narrowed with the improved prices. At that point in time, resistance is encountered and the stock price then tops over to form a peak.
When you connect the support prices and the peak prices where the price tops over, you will find the pattern of a channel or a rectangle.
During consolidation phases, prices trade within a range formed by the bottom of the channel or rectangle and the top of the rectangle or channel.
Technically, the use of oscillators will be suitable for trading within congestion phases. The key is to identify the bottom of the channel and to buy closer to the bottom of the channel and to sell as prices reaches the top of the channel or rectangle.
A common mistake newer traders commit is to continue to use their trend following trading system during a congested phase and encounter a lot of whipsaws as prices oscillate between a small range.
When you transit from a bullish market and moves into a bearish market, be contented with smaller gains which come from trading the congested and consolidation phases. Fall back upon oscillators to track your stock prices and trade them in relation to their location within the price rectangle pattern that you can easily identify in your stock chart,