Consolidation IS Your Friend Many a trader has heard the mantra,...
Consolidation IS Your Friend
Many a trader has heard the mantra, the trend is your friend. But I am here to declare a new mantra, consolidation is also your friend ESPECIALLY in forex trading.
When a currency pair trends for more than 3 candles (candles are timeframe-neutral), the trend is becoming overextended. That is my basic rule. I keep a watch for overextended trends because the longer a trend has lasted the higher the probability that price can turn on you especially if you got into a position at the highs (of an uptrend) or lows (of a downtrend). After spotting an overextended trend, I calculate the Fibonacci retracement levels and patiently wait for consolidation to occur.
Now sometimes I am too early and price continues on in the direction of the trend. If that happens, I look for the next area of resistance or support. If the risk:reward works for me, I will continue to ride the trend. However, if the risk:reward doesn’t work, then I simply wait. The waiting game can be difficult for the undisciplined trader but to become a great trader patience is required. Never chase a trade! Rather, let the trade develop and come to you.
The EUR/GBP has been a downtrend for 7 days as seen in the daily chart. Calculating the Fibonacci retracement level from the January 12 high at 0.9026 to last week’s low at 0.8654, we see that 38.2% retracement of the move lies at 0.8794 and 50% retracement is at 0.8837. Looking at the above chart, you can see that price retraced exactly 38.2% before dropping back in direction of the trend.
For more aggressive traders, consolidation can even become pip-making opportunities as you ride a position countertrend to the Fibonacci level (or support/resistance), take your profits, and enter again this time in the direction of the trend. More conservative traders will set limit orders to enter a trade in the direction of the trend once consolidation has retraced between 38.2%-50%. Even more conservative traders, will wait for trend to resume after retracement and then enter a trade. No matter your trading style, begin to understand that consolidation is just as much your friend as the trend.
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