It’s a simple concept actually if you think about it. What is everyone in the market trying to do to each other? One up each other, out think each other, get in an out of positions before the next guy. Us before them. Me before you. I buy something (stock, currency, option, commodity, etc.) then you buy at a higher price than me and I make money. Right? So, put the market in a situation that we are range bound (the last week of summer trading and days before Jackson Hole is a good and current example) because of the current macro environment, and then think of the participants (traders) looking to square up positions before a big event.
I will use the EUR/USD as an example:
In the chart above, we have identified since last week that key resistance is at 1.2600 (approximately) because of the 38% retracement on the daily chart, and 1.2440 was the breakout point of the bullish wedge. Because of the daily view and outlook the last several sessions, we have now identified as the key “range” between the support and resistance.
Taking a look at the 4 hour chart, start imagining the concept above:
Traders trying to “One up each other, out think each other, get in an out of positions before the next guy.”
As we approach the “event risk” you will have traders putting in limit orders (to take profits) and ratchet stops closer (to minimize risk on a breakout) in front of each other.
Think of it like this….I know you have your stops (at a certain place based on support, resistance, fib level, etc). I know you know that I am going to put my stops there. So, knowing this, I am going to try to put my stops (or limits) a little closer (or farther depending on the situation) to current market prices and in a more advantageous place to where you might be positioned in the market. Looking at the chart above, the little red horizontal lines represent the mentality of setting stops (closer and in front of the next trader) while in a range, and therefore containing prices to a tighter and tighter range before an eventual breakout (as projected by the blue dotted line).
I hope this all made sense. But hopefully, while in a slow moving market, you may have a better idea on understanding why ranges often times turn into triangles or wedges.
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