Thanks to our friends at SharkIndicators.com for the following guest post!
Trading can be much like navigating a vast ocean in sailboat. Sometimes the wind takes you where you want to go with seemingly no effort at all, sometimes you’re just hanging on for dear life in choppy seas, and sometimes it’s calm...going nowhere.
The trick however, is to figure out what the conditions are going to be based on what’s happening now. We all know that predicting the future with 100% certainty is not possible. If you indeed can tell the future, then congratulations, not only will trading will be a VERY profitable endeavor for you, but really you should just buy some lottery tickets with your predicted numbers and call it a day - much easier.
For the rest of us however, that leaves us with the (sometimes tricky) task of actually identifying what is happening right now in the market. Armed with that information, only then can we make decisions on what to do next, or if you’re running an auto-traded system, adjust its behavior accordingly.
Of the many possible market conditions that you can be in, this article’s topic is about identifying when the market is going nowhere. When the ocean is calm.
In trader’s speak it’s called: consolidation.
What is consolidation, and why is it important? Consolidation is when the prices for a particular instrument seem to stagnate for a period of time. In other words, the trading range becomes constricted. On a chart this looks like a narrow ranged zone. Sometimes this can happen with a slight up or down trend, but the overall movement is little, relatively speaking.
Consolidation in the market often means one of two things: there is Indecision in the market, and market players are waiting on some catalyst to induce a trend, or there’s little trading activity going on. During market hours, you generally encounter the former case, and likewise, when the market is closed generally speaking is when you encounter the latter case.
Sometimes, moments before a major announcement (for example: company earnings report) or industry report (for example: FOMC report) that will affect the fundamentals of the underlying instrument you will see consolidation.
So is consolidation good or bad? Well that’s a loaded question, because the answer depends on your system. Some trading systems actively look for areas of consolidation for trade opportunities (for example breakout strategies). Other’s may use it as a signal to exit, or stay clear from trading altogether.
Either way it’s important to recognize it when it’s happening, and more importantly allow your auto-trading systems to compensate and adjust accordingly. You might shut off trades during consolidation periods, or require them as a prerequisite before signalling an entry.
Check out the video below. In it, we use BloodHound to design a system to identify areas of consolidation. With this complete, you can very easily incorporate that information with existing signals, making it a required setup for trade entry.
You can access the video by clicking the link below: