Here's how you can tell if a stock is under consolidation

Avdhut Bagkar | Business Standard
2nd October

Consolidation is a phase in the markets in which a stock or an index trades within a specific range, between the 'support' and resistance' levels. The price reverses from specific lower levels-- the support--and faces selling pressure at higher levels -- the resistance. This scenario, by and large, defines consolidation.

How to identify consolidation

  • During consolidation, the price trades in a certain range with subdued volumes. It faces selling pressure on the upside, near the same levels where supply was witnessed earlier. Similarly, when the price corrects, it rebounds from the levels where buying emerged earlier. Volumes stay low, barring a few swings that can be overlooked.

  • Technical indicators like RSI and MACD show sideways movement during this phase of the markets. Technical indicators are one tool to identify the direction, strength and momentum of the trend. The indicators' inability to trend in any specific direction depicts a consolidation phase.

  • During consolidation, one can often spot candlestick patterns like doji, spinning top, and hammer. Usually, on a breakout, a large candlestick is seen with robust volume, visualizing that a breakout is in progress.

  • Unless there is a breakout with definite consecutive closes, one should not be too quick to 'confirm' a trend. It is very essential to ascertain a trend; sometimes, having a dull scenario on the charts might result in a buildup of shorting positions.

How to trade during consolidation phase

Consolidation shows price moving in a sideways manner, and this exhibits accumulation or exhaustion. When considering any trade, the upside resistance and downside support must be acknowledged. Till the time the support levels are intact and the price does not extend its decline, the reversal opportunity may provide decent returns. Consolidation breakouts have a target which is usually the difference of support and resistance levels.

The major trading signal, called a breakout, happens only when the price moves out of this zone, by breaching either the support or resistance level. There are few moving averages that assist in identifying breakouts. This includes a 50-day moving average (DMA), 100-DMA and 200- DMA. Nearing the breakout scenario, 50-DMA shows a decisive rise. Any convergences of the moving averages further strengthens the trend in the short term.

Consolidation in monthly and weekly charts

A stock's major outlook can be easily studied on its monthly chart. When a price breaks out of consolidation, a major move can be witnessed over a long period of time. This merely explains the investment perspective. Longer the consolidation, the bigger the price move. The sentiment explains the intensity of follow-up buying expected to emerge on the breakout. This triggers a major increase in volumes and, inherently, the price shows buying momentum on correction moves. The stop loss can be placed slightly lower than the breakout candle.

Disclaimer: This information is from a third party—Business Standard—offered through a tie-up to Kotak Securities customers. Click here for complete disclaimer.

The analysis has been done by a Business Standard reporter who is a certified technical analyst. The analysis does not represent the views of Kotak Securities.

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