Stock Consolidation Meaning

Every technical trader’s dream is to trade the stock markets when they have a clear direction. The reason – it is easier to make money when the stock market is headed directly upwards or downwards. But what about when things slow down, and the market starts ranging? In trading terms, this is called “a consolidation period.” In this guide, I will walk you through everything you need to know about consolidation in stock trades, how it can affect your decisions when trading stocks and how to make the most of it. Learn how to use the best stock charting apps to identify stock consolidations and other price action patterns.

What is Consolidation?

It is a condition in which a particular stock struggles to find a clear direction and trades within a limited consolidation range price range. When a stock is consolidating, it is neither going up nor down. Instead of continuing or reversing a trend to generate price breaks, the instrument remains within a narrow trading range. Technical analysts often refer to market conditions as a “sideways market.” It marks moments of market indecisiveness when neither a strong bullish nor a strong bearish sentiment are present.

Think of consolidation as a way for the market to take a breath. During such times, the price chart will rarely offer you trading opportunities.

Consolidation is very common and frequent. In most cases, it comes after a rally. It can last anywhere from a few seconds, in the case of intraday consolidation, to a couple of months or even years, depending on the instrument, its liquidity and time frame. A stock remains consolidated until a bearish breakout or a bullish breakout occurs. Alternatively, until the price exits its trading ranges and forms a new trend.

Why Do Stocks Consolidate?

Financial markets can’t always be in a strong trend. Just the opposite – they need breaks, during which market participants can redistribute their accumulated capital.

Think of consolidation as when you are making decisions in life – you aren’t absolutely confident about what to do next 100% of the time. Instead, you need moments to take a breath and recharge your batteries – even to be indecisive for a moment. This is what consolidation represents – when the market’s next move cannot be clearly predicted. As a result, traders tame their expectations, and the securities start trading in a range without a clear direction.

Consolidation doesn’t happen only with stocks, however. Every traded instrument can be in that phase, although it depends on how frequently consolidation appears and how long they will last.

A Consolidation Example

Let’s take the shares of Apple, for example, to help you identify consolidation. Usually, traders buy the instrument before events expected to affect the stock’s price positively and cause a bullish breakout (or before/after earnings announcements, after an M&A deal is announced, etc.). This leads to a stable rise in the instrument’s price. Once the event or the announcement passes, traders might consider selling to lock in the profits. After the bearish sentiment cools down, the instrument usually enters a consolidation phase.

This is evident many times over the year. For example, during a consolidation phase, Apple shares might stay at $150 for several days. Even if they start moving a bit, let’s say in a range between $148 and $152, the instrument will still be in a consolidation phase.

It will remain in consolidation until traders get more active and cause a bullish or bearish breakout that pushes the stock into a larger price trend.

Is It Good When a Stock is Consolidating?

It depends on what type of trader you are. If you are making just a few trades per month, then it won’t have a massive effect on your strategy.

However, if you are a more active trader (day trader, scalper, or other types of short-term traders), the longer a stock remains in a consolidation phase, the fewer trading opportunities you will have.

While many technical analysis traders deem consolidation phases indecisive and cautious with uncertain movement, in fact, they can be a great moment to take a short break, rethink your strategy and decide what to do next. A stock in consolidation will, at some point, start forming a strong upside buying momentum (or the other way around), so if you time it well, you can put yourself in a position to gain profits once a new trend emerges.

Institutional investors and big trading firms usually capitalize on consolidation periods to rebalance their portfolios and get into larger positions.

How to Recognize a Stock Consolidation Pattern

For beginners, the struggle to identify stocks under consolidation is real. However, experienced technical analysts and seasoned traders can recognize a consolidation pattern as soon as they take a look at the stock’s chart patterns.

Usually, there are three simultaneously occurring properties and indicators that signal consolidation breakouts:

  • There are clear and strong support and resistance levels;
  • The stock remains at one level or trades within a narrow range for an extended period of time;
  • There are low trading volumes without clear major spikes.

Also, note that consolidation typically follows an uptrend or a downtrend. Furthermore, the price move before and after the consolidation often steers in the same direction.

Bear in mind that the time period you use for your charts is also essential since a stock may be consolidating on the daily chart but be highly volatile in the hourly one.

What Happens After a Consolidation and How to Trade It?

Usually, after consolidation, the market rises, embracing a bullish trend (breakout to the upside), or the market falls, forming a bearish trend (breakdown to the downside). The important thing here is learning how to recognize and time it.

First, make sure to assess how long the instrument has been in consolidation. While there is no 100% guarantee to find out how long it will continue if the consolidation has just started and the instrument shows unstable sentiment and hasn’t touched the support or resistance level once, the chance is the price will remain ranging, and a breakout isn’t likely. On the other hand, the longer the consolidation, the bigger the chance of breaking the steady support or resistance point soon.

Next, it’s time to consider potential breakouts. To do that, keep an eye on the support and resistance levels since they can show you the possible reversal points.

When looking for a breakout, always consider trading volumes. If the price touches the steady support and resistance price level while backed by decent volumes, the breakout will likely form a stable trend. On the other hand, if it touches them without huge volumes, a clear bullish or bearish movement cannot be clearly identified, and the consolidation may continue.

Common consolidation strategies and breakout trading techniques include shorting when prices break the resistance level and going long when they drop below the support level. Beginner and more conservative traders wait for confirmation before entering these trades.

After the established breakout, traders can place a stop-loss below the consolidation range or more aggressively directly below the breakout candle low.

It is worth noting that traders who trade at scale (with significant capital or on leverage) can buy and sell even when the instrument is within lower trading range bounds to profit from the slightest movements. However, this isn’t a viable strategy if you lack experience and capital or haven’t acknowledged the trading costs, which can eat up small profits.

FAQ

Is consolidation good or bad?

It depends on the type of trader. Experienced and active traders don’t fancy consolidation periods since they don’t give much room for profits. Beginners appreciate consolidation since it gives them time to plan their next move. Long-term investors are, for the most part, indifferent to consolidation.

How to find a stock consolidation?

You can use technical instruments or a screener. You can also do that manually by assessing whether there are clear resistance and support levels, the state of the trading volume and the trading price/ranges for the instrument.

How long does consolidation in stocks last?

It can last anywhere from a few seconds to over a year or more. How long it will last depends on the trading instrument and how liquid it is. Consolidations for the most traded blue-chip stocks can last way shorter than for penny stocks that don’t exhibit major spikes in volume.

How does consolidation affect the company’s stock price and stock market performance?

Consolidation is a natural market condition that, alone, doesn’t affect market performance significantly. Instead, it is a byproduct of traders’ behavior and lack of decisiveness on how to trade the instrument. Consolidation reflects periods of stable stock prices, but the instrument continues its natural price behavior once it ends.

About the author: Alexander is the founder of daytradingz.com and has 20 years of experience in the financial markets. He aims to make trading and investing easy to understand for everybody, and has been quoted on Benzinga, Business Insider and GOBankingRates.