The formation of trading ranges within the implementation of reversal models can help the trader to make a well-informed decision
Sometimes after reaching the top, the market falls down like a stone, sometimes it starts to lose momentum and form consolidation ranges. As a rule, in the first case, large players do not have time to take profits at the optimal level, as they cannot find the required number of buyers. In order to reduce the risks of such a scenario, they deliberately try to assure their opponents that the uptrend is not yet complete, and the situation may become favorable for the bulls at any moment. Alas, this is just a deception, a trap created in order to take money from the plankton.
With regard to the 1-2-3 pattern, to which several previous materials have been devoted, the formation of consolidation allows us to talk about the varieties of the pattern. Often, the trading range is formed within the wave 2-3, but a wider spread of waves should not scare you, because it allows you to implement a variety of strategies.
The most popular variety of 1-2-3 pattern is the Splash and Shelf model described in Linda Raschke's best-selling book Secrets of Top Trading Performance. She assumes the formation of a peak in conditions of a bullish trend with the subsequent formation of consolidation. Within its framework, the big players who have had a change of heart about the Canadian dollar are trying to identify the presence of serious opponents and (or) close the previously formed long positions in the USD/CAD at acceptable levels. The market mood is changing rapidly, and the bears intercept the initiative in case the lower border of the trading range (the shelf) is broken. This is the entry point to the short position. Conservative traders should click SELL after the closure of the breakout bar. It must be below the shelf.
The Splash and Shelf pattern, unlike 1-2-3, is not an exclusively reversal model. It can be played out in BUY on the bullish market if the quotes have approached the upper boundary of the consolidation range, and then took it by storm and took the buyers to the operational space. However, bears often arrange traps for their opponents. One of them is related to the formation of the pattern Fakeout-Shakeout. The key condition for its formation is an unsuccessful testing or the so-called false breakout of one of the boundaries of the consolidation range.
If the quotes of a currency pair return to its middle, there is your entry point to the short position. A stop order should be set at the level of one of the previous extremes. Conservative trading involves entering into shorts at the breakout of the lower boundary of the shelf. In the EUR/USD example, it is located near point 2 of the 1-2-3 pattern. It should be noted that the Fakeout-Shakeout is an independent pattern and often appears in the charts with no connection to 1-2-3.
If the analyzed pair managed to rewrite both extremes one at a time, and then returned to consolidation, then the probability of the Broadening Wedge pattern formation is high. We will talk about it in great detail in one of the following articles. Now I would like to draw your attention to selling at the breakout of the lower limit of the consolidation range 85.85-87.5 in AUD/JPY and setting a stop order at the level of one of the previous highs.
Using consolidations within the implementation of various reversal graphical configurations is the favorite strategy of many traders. Trading ranges give the opportunity to win some time and think about best entry and exit points, position size and risk. As a result, you make a weighed decision that you feel confident in.
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Price chart of USDCAD in real time mode
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