Throw a baseball straight up into air. As the ball approaches the top of its projectile path it will decelerate to a speed of zero, and then reverse downward picking up speed as it approaches the ground.
Now imagine yourself drilling into a piece of wood. You suddenly hit a hard spot in the wood at which time bear down with all of your might to overcome the temporary resistance created by the knot in the wood.
When you penetrate the knot you surge forward and quickly poke through to the other side. These are two analogies to help explain the patterns of stocks as they transition between one move and the next move.
When a stock is completing a move, it experiences a period of deceleration, which is referred to by chartist as price consolidation.
Consolidation is one of the most important signals that a stock is about to begin a new move.
The move can be a continuation in the same direction, or it can be a reversal in the opposite direction.
The area of consolidation represents a battle zone where the bears are at war with the bulls.
The outcome of the battle often defines the direction of the next move.
As short-term traders, it is important to identify these areas of consolidation and enter a trade just as the new move is beginning.
During the consolidation period or 'battle zone', traders, both long and short are patiently waiting on the sidelines watching to learn the outcome of the battle.
As these winners emerge, there is often a scramble of traders jumping in with the winning team.
The candlestick patterns gives the trader excellent clues on when this move is about to take place, and helps the trader time his entry so that he can get in at the very beginning.
There are four different consolidation patterns experienced by stocks, they are:
- Bearish Continuation
- Bullish Continuation
- Bearish Reversal
- Bullish Reversal.
The Bearish Continuation Consolidation Pattern
Several strong bearish candlesticks precede the Bearish Continuation pattern where the bears are clearly in control (Figure 12).
Figure 12
The narrowing size of the candlesticks toward a line of support indicates that the bears are winning the battle. The bulls finally weaken and allow the bears to penetrate the line of support, at which time the bears quickly conquer new territory by taking the stock to lower prices.
By recognizing the consolidation pattern the trader is able to short the stock just after the stock breaks the line of support, and profit from the sharp move downward.
The cause of the sharp sell off is fueled by the emotions of the traders watching for the outcome of the battle. Traders who bought the stock in the area of consolidation in hope of a rally off of support, are now scrambling to exit their losing positions.
Traders who are short from the period before the area of consolidation are realizing that their original entries were correct and are adding to their winning positions.
The Bullish Reversal Consolidation Pattern
Several strong bearish candlesticks precede the Bullish Reversal Continuation pattern where the bears are clearly in control (Figure 13).
Figure 13
The narrowing size of the candlesticks toward a line against upward resistance indicating that the bulls are winning territory from the bears.
The bears finally weaken and allow the bulls to penetrate the line of resistance, at which time the bulls quickly conquer new territory by taking the stock to higher prices.
By recognizing the consolidation pattern the trader is able to buy the stock just after the stock breaks the line of resistance, and profit from the sharp move upward.
The cause of the rally is fueled by the emotions of the traders watching for the outcome of the battle.
Additional traders who jump in to buy the stock now that its strength has been confirmed fuel the sharp upward move.
Traders who are currently short the stock in the area of consolidation waiting in hope of a breakdown, are now scrambling to cover their short positions.
This buying action also fuels the fire pushing the stock to higher prices.
The Bearish Reversal Consolidation Pattern
Several strong bullish candlesticks precede the Bearish Reversal Continuation pattern where the bulls are clearly in control (Figure 14).
Figure 14
The narrowing size of the candlesticks toward a line of support indicates that the bears are winning the battle.
The bulls finally weaken and allow the bears to penetrate through the line of support, at which time the bears quickly conquer new territory by taking the stock to lower prices.
By recognizing the consolidation pattern the trader is able to sell short the stock just after the stock breaks the line of support, and profit from the sharp spike downward.
Additional traders who jump in to short the stock now that its weakness has been confirmed fuel the sharp sell off.
Traders, who are currently long the stock in the area of consolidation waiting in hope of a breakdown, are now scrambling to sell their long positions.
This selling action also fuels the fire pushing the stock to lower prices.
The Bullish Continuation Consolidation Pattern
Several strong bullish candlesticks precede the Bullish Continuation Consolidation Pattern where the bulls are clearly in control (Figure 15).
Figure 15
The narrowing size of the candlesticks toward a line of resistance indicates that the bulls are winning the battle.
The bears finally weaken and allow the bulls to penetrate the line of resistance, at which time the bulls quickly conquer new territory by taking the stock to higher prices.
By recognizing the consolidation pattern the trader is able to buy the stock just after the stock breaks the line of resistance, and profit from the sharp move upward.
The cause of the sharp sell off is fueled by the emotions of the traders watching for the outcome of the battle.
Traders, who shorted the stock in the area of consolidation in hope of a sell off in the area of consolidation, are now scrambling to exit their losing positions.
Traders who are long from the period before the area of consolidation are realizing that their original entries were correct and are adding to their winning positions.
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