Consolidation Patterns
In this discussion we will be looking at what a consolidation or trading-range patterns. Consolidation patterns occur after a period of rapid increase or decline in the stock price. After the share price has moved quickly in a particular direction it needs to take a rest. This rest period of holding pattern is usually sidewards trend for a while before either continuing on its merry way or reversing the previous direction. A consolidation range is sometimes called the trading range.
A consolidation range can be a continuation pattern or a reversal pattern depending on the prevailing trend. Furthermore, the continuation pattern can be incorporated in other technical patterns. Such as the bull or bear flag formation, the broadening top or any one of the many triangle formations. The pattern can either be in the shape of a rectangle, triangle, pennant or flag.
The chart below is of Oxiana, OXR, from April to May 2007. Notice that the consolidation pattern below is in the form of the bull flag formation. Furthermore, the breakout occurred on the upside therefore it was a continuation pattern.
Trading a share while in a consolidation range can be very dangerous. There are not too many traders who can claim to be able to make money from trading shares that are in a trading range. The reason for this is that generally there is no confirmation on the direction of the breakout, if you are able to guess the direction before the breakout than this is a very profitable trade, however if you guess incorrectly then the losses can be substantial. It is far better, and wiser if traders wait for the breakout before they trade.
Notice the chart below of the XJO (ASX/200) from April to May 2007. There are two distinct consolidation ranges. The first one is a 'bull flag' like formation, while the second one is the consolidation range highlighted in yellow. The yellow area highlights how difficult trading had been in the preceding two weeks. Many traders second-guessing the market would have lost out. It is far better to stay out of the market and wait for the breakout before trading than guessing the direction.
