Anatomy of Price & MA's During Consolidation and Trend Reversal

Jul 1, 2018

Before price makes a true reversal, whether bearish or
bullish, price and SMA's have to make a series of cross overs
in the direction of the reversal. Once every new level of
support for price and SMA's has been made and confirmed,
price then has the base from which to rally.

Of course the easiest and safest way to profit from a trend
reversal is a candle that closes above the upper resistance
trend line, followed by a close above the the highs of the
consolidation zone. However, many of us want to profit
from price action in the lower time frames, too, but often
we get stopped out or lose out on profitable trades
because of the erratic whipsawing which is taking place
in the higher time frames.

Therefore, it is a good idea to analyze and observe what
price and SMA's (and/ or EMA's, which ever you prefer) are
doing on the larger time frames to understand why price
is so choppy on lower time frames.

Realize also that when price is consolidating or ranging as
in this example of GBP/JPY, any trend following indicator
like SMA's and EMA's are useless until price breaks out of
the consolidation zone and forms a trend. Another good
rule of thumb to follow and watch out for, is the 200SMA
and whether it is sloping upwards, downwards or moving
along horizontally. If at any stage on the daily time frame
it is moving horizontally, expect a lot of erratic and
almost illogical price action in the lower time frames,
thus an indication to not hold trades for a long time
until it starts to move up or down.

Moving averages as mentioned above are useless when
price is consolidating, however, they do reveal something
very significant during that process nonetheless, namely,
their levels when they cross over one another.

If after each time price drops as in the example I have shown,
the SMA's are higher than their previous levels than
very often price will have found support at precisely those
levels where the SMA's crossed over on another. This is
far more revealing and provides much more credibility
to price moving higher as opposed to just looking if
price bounces of or is rejected at a single SMA or EMA
level; incidentally, I have found that when one single
candle bounces of a 50SMA for example and then continues to rally
up from there, price tends to be in strong uptrend
already with the SMA also pointing in that direction.
Hence, it is crucial to understand the difference of
behaviour of MA's in relation to price action, i.e. ranging
or trending.

If you look at the candle that broke out above the
consolidation zone, note that below the 100 & 200SMA
made a final bullish crossover and all the SMA's were
sloping upwards, and this is quite interesting in that
we know MA's to be lagging indicators. But they do
indicate momentum building up so that we can be
prepared for a move to the upside, as in this example,
when price breaks out of the consolidation zone, thus,
it seems as if the SMA's are not lagging at all, but this
is due to the fact, as mentioned above, that price is now
trending and the SMA's start to indicate and support
the trending price action, hence changing their behaviour
to confirm price is no longer consolidating.

A brief look at the RSI indicator also is indicative of a
bullish trend reversal about to occur when observing
the divergence and convergence between price action
and the SMA movement. For those new to trading and
using momentum indicators such as the RSI, remember
that overbought or oversold conditions dont immediately
imply that price will drop or rise once it reaches those
levels, instead price usually enters overbought or oversold
levels after a breakout which indicates momentum in trend
in the direction of the breakout. Only after the RSI crosses
from above or below extreme levels can you start
anticipating a corrective move, but never necessarily a
reversal of the trend.

In summary: When price is consolidating look for SMA crossover levels as support.