Much like the first dynamite compound invented by Swedish chemist and engineer Alfred Nobel, consolidation periods and patterns in the currency markets can explode, leading to great profit opportunities for the FX trader. Sometimes suggestive of indecision, consolidation periods are great for capturing potential because the burst of directional action that follows can last for an extended period.
The flag formation is one of two consolidation patterns that can lead to great profit opportunities. Common in the currency markets, the flag formation serves as an indication of continuation (i.e. a continuation pattern). This type of consolidation occurs after a significant uptrend and is usually referenced as a stopping point before further strengthening momentum ensues. With this type of formation, the duration of the consolidation period is rather short and tends to go against the previous uptrend direction.
Sound money management should always be applied to any trading position. In this situation, the stop-loss order will be placed two-thirds below the previous session's high. The underlying theory is simply that if the price breaks back below the upper trendline, the close above was simply a fakeout and the trend is being contained. In this trade, the stop would be placed at 209.77 (see Figure 2).
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