If you closely follow market indices you will notice that at times after a robust breakout that takes the market too far too soon, the strong trend comes to a halt and the market starts gyrating within a narrow range. It is not an uncommon situation; occurs when traders suspect possible overbought or oversold positions. In stock market parlance, it is called moments of market consolidation.
Stock consolidation is a market condition that refers to when the stock trades within a narrow price range, neither continuing nor reversing the trend. Since the stock price moves in a limited range, it offers very few trading opportunities.
For traders, especially if you are new, the struggle is real to identify stocks under consolidation. Therefore, in this article, we are going to discuss
– What is stock consolidation
– How to identify consolidation in a chart
– Trading in consolidation
Technical traders and analysts consider the phases of consolidation indecisive and warn traders to move with caution during it. Most describe movement during consolidation as sideways, without significant shifts in price.
Consolidation is a common condition that occurs frequently, and if you are planning to day trade, it is important to thoroughly about it. here are the key factors to keep in mind about consolidation
– During the consolidation phase the stock in question trade within a limited range
– To identify stocks in consolidation look for those that have steady support and resistance, with price moving in a narrow range, and have low trading volumes
– Trading in consolidation depends on how long the pattern has lasted. Although there is a small room for profit, one can still trade in a range
How To Identify Stocks Under Consolidation
One can say that a stock is under consolidation when the following three conditions coincide.
– The stock has identitied range and steady support and resistance, creating a flag-like pattern in the chart
– The second trait is a narrow trading range
– To confirm if a stock is under consolidation, check its volume, which will be low without spikes
Consolidation indicates moments of market indecision when there is no shift in price. It is neither positive nor negative. Usually, after a price burst or strong trend movement that market falls back into a phase when traders are cautious about possible overbought or oversold positions. During this period, market reconciles before another breakout or trend emerges. Once you have identified consolidation, the next step is to keep an eye on a possible breakout.
How To Trade In Consolidation
Consolidations are bad for directional traders as it kills the direction. But when such situations occur, investors need to trade carefully. Here are some tips to trade in consolidation.
Reduce Trading Limit
While the stock is under consolidation, it doesn’t show strong price movement. Hence, the opportunity for profit gets reduced. Accordingly, investors must lower their trading horizon to avoid losses. Day traders need to identify trends with the possibility of achievement during the day. Suppose you are trading in options, select call options with a lower strike and put with a higher strike. By going deeper into money, you can increase the profit margin.
Select Spreads Instead
It is easier for you if you are an options trader. If you identify a trader set-up and expect its to take days to materialise, then trade in a spread instead of buying single options. The spread can include a call selling a higher strike price and a put selling at a lower strike.
Increase Prudence Level
When it becomes clear that a stock has entered a consolidation phase, you can optimise your profit by exiting a bullish trade close to the resistance level and book profit. In case there is no open trade, wait for a breakout trend to confirm.
Consolidation Trading Strategy: Breakout And Breakdown
Trend traders don’t have to feel bad because a consolidation almost always results in a new trend, on either side. It is common during consolidation for a support level to become the new resistance after a bearish breakout or the resistance to become new support line when the breakout is bullish. Sometimes consolidation can last for days, weeks, and months. Also, during intraday, it can last for a few minutes. Before trading in consolidation, you need to determine the duration and seek price confirmation before trading in the direction of the trend.
When you are intraday trading, consult trading software for dynamic updated to predict a breakout correctly.
One of the common strategies to trade in consolidation is to check out for breakout or breakdown.
Breakout is when the trend reversal is bullish, usually accompanied by an increase in volume. The resistance level turns into new support. Traders enter a long position when the stock breaks out from the resistance line.
Similarly, a breakdown is a condition when the breakout happens in the downward direction. The stock moves sideways for a while and then takes a plunge. It occurs mainly due to internal weakness of a stock.
While breakouts are common and good for trade set-ups, it must confirm the following
– Must have a tight consolidation range, often a triangle or pennant pattern
– Moving average is below 200
– A tight trading range
Another trading strategy involves when the stock trade in a range. Sometimes, the stock price keeps bouncing off the resistance and support lines over a time period. In such cases, traders usually look for buying opportunities at the bottom of the range and sell-off at the resistance level.
The Bottom Line
Since consolidation is a common phenomenon, day traders must learn to identify and trade in consolidation. While trading in breakout patterns is quite a straightforward strategy, traders must watch out for false breakouts which are quite common, especially after a long consolidation phase.