How to Trade Crypto: High Risk, High Reward Consolidation Patterns
How to anticipate weakening support and resistance levels in order to take advantage of potential reversal patterns
By White Wolf Trader
This tutorial teaches cryptocurrency trading — primarily large and mid caps like Bitcoin (BTC/XBT), Ethereum (ETH), Litecoin (LTC), XRP, and EOS — through price action-based concepts and theories. Price action-based trading (PABT) assumes it’s possible to effectively trade an asset by studying nothing but the movements of price. PABT typically doesn’t involve the use of indicators (like RSI, MACD, or OBV): indicators are considered unnecessary, unhelpful, and/or misleading when it comes to reading markets and planning and executing trades.
Disclaimer 1: The information contained in this post is for educational purposes only; it does not constitute, nor should you consider it as constituting, financial advice of any kind.
Disclaimer 2: It’s possible this article unintentionally contains one or more errors or misleading claims. Always do your own research (DYOR) before entering or exiting a trade.
Crypto-Trading Tutorials 1. Top-Down Market Analysis 2. High Risk, High Reward Consolidation Patterns 3. Four Strategies for Finding High-Probability Targets
Price Only Ever Does One of Two Things: It Consolidates or It Expands
Regardless of the asset under consideration, price only ever moves according to (i.e., it only ever forms) one of two patterns:
- Consolidation: a period of relative ‘calm’ in the market wherein, on the whole, price moves within a defined range known as the ‘dealing range’, which is marked by an identifiable high and low. When you hear somebody say price is “range bound”, “ranging”, or “consolidating”, they mean price is (mostly) staying within a specific area. The range can be very tight (e.g., a spread of only a few dollars) or very loose (e.g., hundreds or even thousands of dollars from range high to range low); this depends, in part, on the timeframe under consideration; and
- Expansion: a period of ‘violence’ in the market wherein price rapidly and acutely moves in one direction or the other. A big ‘pump’ to the upside or a massive ‘dump’ to the downside, marked by huge candles (big bodies and/or wicks), is the sign of expansion.
Of course, it’s possible to identify many more types of patterns withinpatterns of consolidation and expansion.
On a macro view, however, price only ever does one of two things: it consolidates (stays range-bound) or it expands (pushes out of the range).
Here’s an H6 XBTUSD chart showing examples of both consolidation and expansion (the light grey boxes correspond to expansion and the dark grey boxes to consolidation):
As is evident from the above chart, consolidation always precedes — comes before — expansion.
This is important because:
The goal of trading consolidation patterns is to learn how to spot solid trade entries BEFORE price pumps or dumps (i.e., expands). Rather than chasing price as it breaks out, which very often leads to liquidation (big traders love to trap breakout traders who succumb to FOMO), you should try to get in on a big move before it becomes obvious to everybody else.
In this article I’m going to show you several strategies for anticipating potential price expansion by looking for specific types of consolidation patterns.
Specifically, I’m going to teach you how to spot a) long opportunities when ‘resistance’ isn’t doing what it should and b) short opportunities when ‘support’ isn’t doing what it should.
I consider these trade setups to be high risk/high reward because they involve entering a trade before ‘confirmation’ — such as a volume spike or the break of a key level — has presented itself:
- High risk → it’s easy to get stopped out if the trade doesn’t go your way (or if you’re right about the expansion but it comes after a quick stop-run).
- High reward → you can make big gains if the trade goes your way, particularly because you get in before others realize what’s happening.
Sometimes, price expands so quickly that there’s simply no chance to enter a trade fast enough; and if you enter too late, you risk getting burned on a pullback.
To use a simple metaphor, what I’m going to show you below is based on the idea that you want to board the train before it takes off; but in order to do so, you risk buying a ticket to a ride that might never leave the station (or, in the case of a stop-run, that kicks you off the train and then leaves without you).
A Quick Overview of Support and Resistance
Support and resistance are two hallmarks of trading in general and of PABT in particular.
Conceptually, they’re very easy to understand:
- Support is a level off which price bounces to the upside; support ‘holds’ price up.
- Resistance is a level from which price rejects to the downside; resistance ‘pushes’ price down.
Here’s a D3 chart for LTCUSD showing two examples of HTF support levels:
And here’s a D1 EOSUSD chart showing an example of HTF resistance:
Now, things start to get interesting whenever the reactions at support or at resistance become progressively weaker.
Weakening reactions tell us a potential trend reversal is approaching.
Think about it like this:
- If a level is supposed to be acting as support, price should keep bouncing off it to the upside; but if these bounces are becoming less and less pronounced, this could signify support is starting to crumble (e.g., that buyers are stepping in to defend the level less and less each time).
- If a level is supposed to be acting as resistance, price should keep rejecting from it to the downside; but if these rejections are becoming ever-less violent, this could be an indication resistance is starting to fade (e.g., that fewer and fewer people are selling (or shorting) at the level with each touch).
Looking for areas of weakening support or resistance under specific market conditions rests at the heart of the high risk, high reward consolidation setup I’m now going to teach you.
Consolidation + Support/Resistance
Here are two basic rules of PABT I want you to drill into your head.
- Consolidation on top of support is BEARISH.
- Consolidation underneath resistance is BULLISH.
Yes, there are plenty of exceptions; but, often, the above rules hold true.
If a level is truly support, price should bounce off it and then head in the opposite direction (i.e., to the upside).
If a level is truly resistance, price should reject from it and then dump to the downside.
- If price drops into ‘support’ but continues to hover around the level, it’s a possible sign support will be lost and price will dump.
- If price runs into ‘resistance’ but continues to hover around the level, it’s a possible sign resistance will be lost and price will pump.
Bitcoin’s massive dump late last year from $6k is a perfect example of weakening support leading to a huge drop:
The opposite applies as well, i.e., weakening resistance leading to an upside pump (see examples below).
How to Trade This Pattern
There are three key elements to trading this pattern successfully:
- Spotting an area of consolidation underneath resistance (longopportunity) or on top of support (short opportunity).
- For consolidation underneath resistance, confirming a series of higher lows; for consolidation on top of support, confirming a series of lower highs.
- Setting your SL (stop-loss) and TP (target price) in way that guarantees at least a 2:1 R:R (reward to risk) (don’t ever enter a trade if you can’t make at least twice as much money as you’re willing to lose).
The examples below are all long trades based on consolidation underneath resistance, but the exact same principles I discuss therein also apply to short trades based on consolidation on top of support—just in reverse.
(Remember: you look for higher lows with longs (weakening resistance) but for lower highs with shorts (weakening support).)
Example 1: ETHUSD (Bitfinex) — Longing Consolidation Underneath Resistance — 5.20% Gain; 2.5:1 R:R
Example 2: XBTUSD (Bitmex) — Longing Consolidation Underneath Resistance — 7.04% Gain; 5.5:1 or 2.34:1 R:R
The above two examples are the ‘standard models’ I look for when trying to find these kinds of consolidation-based setups.
When it comes to entries, the most reliable approach seems to be to enter right after the last pullback before the pump, i.e., just as price is squeezing underneath the resistance (or hovering just on top of the support in the case of a short setup).
The issue, of course, is that if you wait too long to enter, you might miss the pump entirely; but if you’re too eager, you might get stopped out on a dump.
In general, the tighter the consolidation squeeze, the higher the probability of a massive expansion.
If you can be patient enough to wait until price enters into the apex, you’ll reduce the chances of losing the trade; the downside is that you’ll miss entries on some occasions because expansion will occur before you’re able to hop on for the ride.
Another way to trade this consolidation pattern is to combine it with HTF analysis and LTF PA.
The following example shows how to do this.
Example 3: LTCUSD (Bitfinex) — Longing LTF Consolidation Underneath HTF Resistance — 9.43% Gain; 6.04:1 or 4.32:1 R:R
One Word of Caution
Sometimes, market makers run stops right before they pump or dump a coin:
- Just before price pumps, it temporarily dumps: this causes people who are in long positions to get shaken out as their buy stops (sell orders) are triggered.
- Just before price dumps, it temporarily spikes up: this causes folks in short trades to get liquidated as their sell stops (buy orders) are triggered.
Big traders often use these short-term reversals as a way to generate more liquidity for their own orders.
When you trade a consolidation pattern in expectation of forthcoming expansion, you have to be aware of the possibility that price will shoot in the opposite direction for a short period of time before it then moves as you originally anticipated.
Normally, the most recent low (for a long setup) or the most recent high (for a short setup) is violated, people are forced out of their trades, and then price pumps or dumps.
No, this doesn’t always happen—neither of the examples I reviewed above involved such a situation.
But it does indeed happen from time to time—especially if there are equal lows or equal highs near the apex of the consolidation.
There are several strategies for dealing with this possibility, including:
- Using a wider-than-normal stop-loss;
- Entering as close to the apex as possible; and
- Reentering if necessary, especially if price closes as a swing failure pattern (a topic for another day) and/or bounces into a demand or supply zone and then reacts immediately.
No matter the asset, price only does one of two things: it consolidates or it expands.
Certain consolidation patterns hint at upcoming price expansion.
One such pattern is consolidation underneath resistance or consolidation on top of support.
- Consolidation on top of support is BEARISH.
- Consolidation underneath resistance is BULLISH.
These forms of consolidation suggest potential forthcoming trend reversals as they give clues that ‘support’ is failing to hold price up and ‘resistance’ to push price down.
The key to longing consolidation is confirming higher lows; the key to shorting consolidation is confirming lower highs.