Channel contractions
Channel contractions are pattern whose tops and bottoms get approaching each other. These figures, called flags, pennants, wedges or triangles, appear out of hesitation. All those patterns represent the same corrective phase, after an impulsive leg. Many books about trading do distinguish between shapes or time frames, though.
The key point to remember about this type of formations is: they are good places to trade. Price usually breaks it following the former trend. But that’s not as important as the fact that there is a range contraction. Thus, at those spots, the reward to risk is almost the double in comparison to its starting point.
Fig 1 shows an example of a channel contraction. There we can see at 1 the risk at its beginning and at 2 the risk at its end.
False breakouts
We should note that sometimes a false breakout happens in the opposite direction before price turns toward the real trend. that’s what happened on the MSFT and USDCHF charts below. These are mostly market manipulations by institutional trades in search for good liquidity.
To trim losses, we must close the position if a candle closes above the broken support. Especially so, if the breakout happens in the opposite direction to the previous trend. It is fair to enter in the same or opposite direction if another breakout in that way is spotted.
We can see that usually, the reward-to-risk factor is higher than 2, which is great.
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