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Consolidations and Pullbacks For Confident Trading

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Why do I often mention to use lower time frames when I post my weekly Forex and Cryptocurrency setups?

Because lower time frames can give you a better view of the imbalance that is playing out on other time frames.

This can result in:

  • Better entries giving the trade room to run before any potential support or resistance zones show up
  • Keep you out of trades that look strong on the daily but show weakness on the four hour chart
  • Can set up lower time frame trades counter to the higher time frame for quick trades

One thing I did not say is that it gives you lower risk trades.  There is no such thing in the general concept of risk but there can be trades where you use a different risk profile.

I often take a smaller position on reversal trades against the trend but by no means is the overall risk different – I can still lose.

 

EURAUD Pullback Example

One of the blog readers, Shingi, asked a question about the EURAUD that is posted in the comments.

 This week’s EURAUD set up, you say ” consolidation or pullback for another upside shot”, what is your reason to wait for a consolidation or pullback and not go long straight away?

I don’t want to attempt to decipher why that question was posted but I will say that when traders see large momentum candlesticks, the initial impulse is to just jump on the trade on the fear of missing out on a trade.

Fear of missing out is a very real and very dangerous fear to have. Accept that you will miss trades especially if you trade with limit trade orders.

This is the chart that was posted over the weekend prior to the market open on Sunday Jan 14/18

 

Why would I consider long trades when price is making lower highs and lower lows?

Remember…as swing traders….we want one clean swing in the market regardless of trend direction IF price is showing that potential.

  • Price had been trending down
  • Reversal off lows with momentum candlestick that is obviously different from most that came before it
  • Price had complete a measured move from the highs of this chart

Is this a perfect setup? 

Not really.

I would have preferred a stronger exhaustion to the downside which would have added more importance to the large candlestick.  However, large momentum thrusts as we saw here often mean revert and then lead to another move in the same direction.  The character of the pullback is important.

I am playing the odds that have come from back testing – there is an edge in this type of trade.

Is that enough to just market in and go long? 

No.  Price is still evolving and we needed to see something else that showed the bulls are taking over.  We can do that by watching price inside of consolidations and the character of the pullback that comes after this thrust.

 

Inside Consolidated Price Pattern

Let’s look at consolidations and to do so, I am going to use a graphic from a previous trading article about trapped traders.

Inside of lower time frame consolidations (sideways range), we can often see clues where the imbalance leans towards – buyers or sellers.  Seeing pokes below support of a range and quick returns inside the range (for long trade interest) show that lower prices are being rejected.

That is bullish and I will often enter trades in those areas.

The key is that I am not using a range trading approach where I buy lows and sell highs.

I am using the lower time frame pattern to position inside the higher time frame pattern.  This is vital to understand.  As well, all decisions from stop to trade targets are based on the higher time frame chart.

 

Why Wait For A Pullback?

To be clear, I consider pullbacks and ranges as consolidation moves as they often share the same purpose.  The character of the pullback will also show who has the balance of power.

This chart is showing the 1 hour time frame with an inset of the weekly so you can see the weekly did show signs of strength. I have also included an inset of the daily chart showing what you do not want to see in a pullback for a continuation trade.

Advanced traders could see on the four hour chart what the one hour chart shows and for ease of explanation, I will use the one hour chart.

The vertical line is the beginning of the trading week.  The red lines are marking of the swings of interest and the question is, what type of trending pattern is that?

It’s not a trending pattern and shows consolidation instead of a trending pattern.  We would need to see higher lows holding or increasing to consider a long trade. – it is not doing that.

Does that mean longs are off the table? 

Yes, at least for the moment.  The market never showed bull strength since that thrust and the character of the pullback actually shows weakness in the EUR on this pair.

  • The consolidation did not show a strong bias for either direction
  • The pullback started to break down with momentum which is not what we want for a continuation trade

 

Remember Large Momentum Moves?

Earlier I mentioned that large momentum pushes often mean revert and then will often set up another push in that direction.

I want to draw your attention to the green arrow on the chart.  What do you see that would give you some confidence in a short trade?

  • Strong momentum push to the downside that ate up most of the range
  • Lazy pullback in price (bear flag)
  • Profit target is the A-B=C-D and price terminates at the last pivot low before price breaks through

These patterns play out on all time frames – I just prefer higher time frames for bigger runs and a more “hands off” trading style.

 

Every Week Is The Same Approach

When I post my setups online for both Forex and cryptos, this is a generalized way I look at every single chart.  There is no mystery but does require a lot of proper chart time looking for things that have an edge in the market.  There is an edge in this approach – unlike most approaches that are trading dogma.

Keep things simple and always ask “why something should work”.

 

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