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Day Trading: What Is A Consolidation Area?

In this article I will take you through a deep dive into a full comprehensive ‘consolidation area’ lesson. You’ve probably heard the term in trading circles or through online forums, but just what does it mean? What is a consolidation area and more importantly how can learning about consolidation areas help you become a more profitable trader?

Firstly, understand that there are many concepts to learn in day trading, and the consolidation area is definitely an important one, but knowledge alone is not enough for success. You must apply on the charts fundamental day trading skills and principles in addition to your knowledge of market movements. 

But technical skill development is for another lesson and today we will be focussing solely on the subject of consolidation areas in day trading.

The consolidation area is one of the most common areas found in a chart and its basic day trading lingo. In fact, it’s so commonly used that you even find consolidation indicators around online. And since it’s commonly found in trading, it’s vital that traders know how to identify a consolidation area and how to trade it if they choose to or stay out.

If you’re a beginner it’s normal if you’re thinking, “But, Trader Chick, what is a consolidation area?”. And you shouldn’t be worried, I got you covered. I’m going to tell you everything you need to know about a consolidation area.

A consolidation area can be REALLY profitable if you know how to read the market. You can find a lot of information around on how to identify a consolidation area and how to trade them. The breakout of a consolidation area is usually a continuation of a trend.

First of all, let’s see what a consolidation area is.

What is a Consolidation Area?

The consolidation area meaning in stocks or in the financial market is pretty simple, the short answer is:A consolidation area is a term used when security or stock is neither going ahead nor going backward in the price range and in terms of a trend. It’s there, in the middle.

When consolidation happens the price usually bounces from a price range to another in a determinate price area. You can set your support and resistance right there i.e at the points where prices bounces either at the top or at the bottom of the range.

How Can You Identify a Consolidation Area?

There are a few tools and identifiers traders use to identify whether or not they are in a consolidation phase.

One of the simplest would be to identify support and resistance levels on your chart and if price stays within this range for extended periods then it’s likely a consolidation area.

Indicators such as the RSI or MACD also can show sideways movements when the market is in a consolidation phase, so these indicators can be helpful to identify if you are in a consolidation area.

Candlesticks are another useful tool for knowing when we are in a consolidation area and the candlesticks patterns of Doji, Hammer and Spinning Top can be seen in these types of consolidations.

But keeping things simple when identifying consolidating markets can be done by looking for steady support and resistance levels. When in a consolidation area price will move within a narrow range (between the support and resistance you have identified) and you can also look for low trading volumes.

Here’s a consolidation area example, that’s an easier way to understand it.

You can learn more about sideways trading here

Consolidation Area Example

 what is a Consolidation Area?

Related Read: Day Trading Terms And Definitions 

As you can see in the example, the consolidation area has the price bouncing from 2272.00 to 2277.00. It’s consolidating. You can set a support and resistance area right there. But it’s pretty easy to identify when they have already been shown in the chart, right? Usually, you will find consolidation areas in stocks or securities with low trading volume.

A consolidation area or a sideway market is not bad by his own. As I mentioned before, a lot of traders profit from a price action pattern like this one.

How to Trade a Consolidation Phase?

So how can you trade while the market is in a consolidation phase? 

As you know my philosophy is to not trade at all and avoid completely the market altogether during a consolidation phase. But you don’t have to follow exactly what I do and you should be able to make your own decision.

Many traders are quite successful and able to make profit during a consolidation phase.

So I think it’s important to at least have some strategies and trade setups that you can backtest and try (using very small capital at first to reduce your risk) and see if this style of trading suits you.

a consolidation phase is when price moves up and down within a fairly narrow range. The resistance level can be considered the top of the range and the support level the bottom of the range.
A consolidation phase is when price moves up and down within a fairly narrow range. The resistance level can be considered the top of the range and the support level the bottom of the range.

Here are a couple of common ways traders implement their trading during a consolidation phase:

i) Range Trading

With trading you trade between the support and resistance levels you already identified that confirmed you are in a consolidation area. 

As discussed above a consolidation phase is when price moves up and down within a fairly narrow range. The resistance level can be considered the top of the range and the support level the bottom of the range.

As consolidation means price moves within these levels repetitively you can buy near support and sell near resistance.

You could also use oscillators like the Relative Strength Index (RSI) or Stochastic Oscillator to identify overbought and oversold conditions within the range.

ii) Breakout Trading

This is my preferred way of trading when I come across a consolidation area. And while technically it’s not trading in the consolidation area (we actually wait until a breakout above or down movement below the resistance and support levels).

As a consolidation phase pretty reliably moves between these ranges, any breakout out of the set range could be a signal that price will make a more definite move in that direction.

An increase in volume is a pretty good way to support your trading hypothesis that price will move with more conviction and you can trade accordingly. Bollinger bands are also useful when looking for a breakout from a range.

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Understand Conceptually a Consolidation Area

Again markets are in consolidation phases for extended periods of time so it’s vital for you as a trader to know when you are in this phase. And also what this phase represents – which is basically indecision in the markets with no clear direction.

And to drive this important point home here’s a funny example of a consolidation area you should use and remember:

Funny example of a consolidation area you should use and remember.

Imagine you are driving from NY to DC.

It’s a pretty straight forward.

You’re driving, determined.

But then…

You realize waze or google maps isn’t working properly and you aren’t going the right way.

So you start to veer around, ask for directions, basically not moving forward.

Then you get a call that your dog is vomiting. It’s nothing serious, but you pull over and start calling friends and family to see who can help you take it to the vet since you’re home.

Not you’re wondering if you should even go at all.

This is consolidation.

It’s doubt, it’s confusion, it’s second guessing, it’s total INDECISION.

A consolidation area is a sign of indecision in the market with neither buyers nor sellers showing decisive movements.
A consolidation area is a sign of indecision in the market with neither buyers nor sellers showing decisive movements.

This happens in the market ALL.THE.TIME.

Probably for different reasons, but one never really knows.

It’s humans and we all have crazy, emotional, unexpected reasons why we back down, turn around, keep going, take a break.

NEVER QUESTION THE CONSOLIDATION – the slow down. The sideways movement.

We are not hear to question it or judge it, we are here to read it. And when we see CONSOLIDATION

WE STAY OUT ENTIRELY!!!!!!!!

Consolidation areas are fiercely known to rob traders of all their winnings and entire accounts.

Do NOT be one of those TRADERS!

If you have any questions about trading strategies you can always ask them in my Facebook Group and if you want to learn day trading basics – check out MY Courses.

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