Investing > Complete Guide to Stock Consolidation

Complete Guide to Stock Consolidation

Everyone needs a break from growth in life. And when a stock takes a break from rapid growth or decline, this is known as 'consolidation'. 

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Updated January 09, 2022

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Are you sometimes a little indecisive in life?

As it turns out, stock prices can be a little indecisive too. 🤷‍♂️

Well, it isn’t really the stocks that are indecisive, but the investors, and this causes the price of a stock to stay in the same range for an extended period of time. This period of indecisiveness is called stock consolidation, and there can be benefits to learning how to trade it. 💡

Stock consolidations can be a good indication of an upcoming price breakout, and sometimes investing in a stock during a consolidation can be a good idea. But there are times when this isn’t the case. Disney investors found this out the hard way when Disney stock, which was in a period of consolidation from May 17th, 2021, until November 1st, 2021, took a sudden plunge due to the lack of Q4 earnings

The point is, trading a stock consolidation can be tricky. So keep reading to learn more about stock consolidations, when you should trade during them, and when it’s probably a better idea to let them be. 

What you’ll learn
  • What is Stock Consolidation?
  • Finding a Stock Under Consolidation
  • Stock Consolidation Patterns
  • How to Trade Consolidating Stocks
  • Conclusion
  • Get Started with a Stock Broker

What is Stock Consolidation? 📚

Stock consolidation is a term that is used to refer to a stock that is neither going up or down or if it is, it’s only going up slightly to return to where it was before and vice versa. This is also called trading within a range. Consolidated stocks are typically recognized by the fact that they only trade within a very limited price range. 

It’s important to remember, however, that different products have different levels, and what may be a limited price range for one product may not be a limited range for another. A prime example of this is Bitcoin. 

If a stock like Disney or Ford fluctuated a few hundred dollars a day, this would be a huge newsworthy event. But when a cryptocurrency fluctuates a few hundred dollars a day, compared to how volatile it was before, this could be indicative of a consolidation, especially if it previously varied thousands of dollars per day. 

The reason you should watch for stock consolidations as an investor is it could indicate a future breakout of the stock. But remember that this breakout could be either positive or negative, and you’ll need to perform some basic stock research before purchasing any stock that appears to be consolidating. 

And there is always a chance that stock consolidation could mean nothing at all. This is why you need to be careful as you perform your stock analysis to know what you are looking at. 

Finding a Stock Under Consolidation 🤔

It’s difficult to find something if you don’t know what it is you are looking for.

Which is why it’s important to know what exactly a stock looks like when it is under consolidation. Remember that stock consolidation typically comes after a big up or down movement for a particular stock. 

After you identify a large movement followed by a change in trading volume, you’ll want to look for some other key characteristics. 

A stock under consolidation will have the following characteristics:

  • ☑️ Established support and resistance levels
  • ☑️ A narrow trading range (remember, this is stock-specific)
  • ☑️ No major trading spikes

Let’s take a look at what this would look like on a chart:

Rectangle consolidation example on a stock price chart
Consolidations are stable periods in the price of an asset, followed by either an upward or downward trend. Image by TradingView.

As you can see, the stock in this chart was on a clear upward trajectory, which was interrupted by a period of consolidation. During this time, there were a few small ups and downs but the stock was staying right around the same price. There are no major trading spikes, and the support and resistance levels are established.

On a chart, stock consolidations appear as a somewhat flat line. Of course it won’t be perfectly flat, as people are still trading the stock, but there should be no major movements for an extended period of time. 

After the consolidation was finished, the stock experienced a breakout in which it experienced a rapid upward trajectory. This is a good example of when purchasing stock during consolidation would have worked out in your benefit. 

If this looks familiar, this is because it should. Stock consolidations are a normal aspect of trading the stock market and are a huge part of what keeps the market in balance. 

Generally, you can find charts to look for stock consolidations as you do some general research on stocks, or many of the top apps for stock trading will provide free stock charts to their customers. 

Stock Consolidation Patterns 🗃

Obviously, the reason you are here is to learn how to make a profit off of trading consolidating stocks. While stock consolidation trading is just as risky as any other type of stock market trading, you can make it much more reliable by properly spotting and analyzing certain chart patterns.. 

Stock consolidations are unique in that they must always come to an end. This leads to two types of consolidation patterns.

There are breakout patterns where the stock may be experiencing a consolidation but are still trending slightly positively, in the direction of a breakout. There are usually the consolidations you want to try and trade.

Then there are breakdown patterns, which are consolidation patterns that trend in the negative direction ever so slightly. Although you don’t want to buy anything in this scenario, you will want to know how to recognize them to avoid or short them. 

Below are all the different types of patterns of stock consolidations. It’s important to note that any of these can be breakdown or breakout consolidations depending on the trend of the chart. 

Rectangle ⚖

Stock consolidations aren’t always in a straight line like the one pictured above. But when they do look like this, they are called rectangle consolidations. Rectangle consolidations can either be breakout, or breakdown consolidations depending on changes happening within the rectangle. 

This pattern is called a rectangle because as the stock bounces off of the support and resistance levels in it’s small trading range, this forms what looks like a rectangle on the chart. Take a look at this chart of Disney (DIS) stock from 2021.

Rectangle consolidation pattern example
Rectangle consolidation pattern example. Image by TradingView.

As you can see, DIS underwent a period of consolidation from mid-May to mid-November. This is clear because the trading range forms a rectangle on the chart, the consolidation comes after a period of change (decline) and the stock trades within a narrow range of $170-$182 for this entire time period. 

This is a pretty good example of a rectangle range consolidation, but as you can see it is a breakdown consolidation because towards the end of the rectangle, the price maintains a negative trend. The consolidation eventually ends in a breakdown. 

Symmetrical Triangle 📐

If all stock consolidations were rectangles, your job would be easy. Unfortunately, the most common stock consolidation pattern is the symmetrical triangle. 

Like the rectangle, a symmetrical triangle will follow a period of change for a stock. But then, instead of trading in the same range for a period of time, the stock will trade in a range that becomes increasingly smaller over time. This will form a triangle on the charts. 

Symmetrical triangle consolidation example
Symmetrical triangle consolidation example. Image by TradingView.

This is a chart of the price of gold at the end of 2019 and beginning of 2020. As you can see, Gold underwent a period of consolidation that formed a triangle as the range of the consolidation became smaller. The consolidation ended when gold experienced a breakout. 

The significance of the triangle is that many day traders will say that you want to trade as close to the convergence point, or tip of the triangle, as possible. 

Ascending Triangle 📈

There is another type of triangle to look for when looking at consolidation patterns. This one is less common than the symmetrical triangle, but it does happen so you may come across it.

The ascending triangle is characterized by a resistance level that is never broken while the consolidation is occurring, while the support level will move increasingly closer to the resistance level. This forms an ascending triangle. 

Ascending triangle pattern example
Ascending triangle pattern example. Image by TradingView.

This example is from First Trust Water (FIW) from January 2018, to July. During this time, you can see the resistance is almost exactly $49.50 the entire time. 

But the support level gets increasingly closer to the resistance line until the consolidation ends and the stock experiences a breakout. It is pretty clear to see that this particular stock pattern was a breakout pattern the entire time, as it maintained its upward trend even during consolidation. 

Descending Triangle 📉

Of course if there’s an ascending triangle, there also has to be a descending triangle. This stock consolidation functions in the exact opposite way. 

The support level of a descending triangle consolidation will hold firm, while the resistance level will steadily decrease until a point of convergence is reached. You can see this happening with the DuPont de Nemours stock (DD) in the chart below. 

Descending triangle pattern example
Descending triangle pattern example. Image by TradingView.

DD has an established support level, which you can see in the straight line in the chart. The resistance level is going down, however, creating the descending triangle. This is a breakdown consolidation pattern, as the negative trend continues during the consolidation, eventually ending in a breakdown. 

Cup and Handle 📊

One interesting form of consolidation is the cup and handle. This is when a stock was trending downwards, only to experience a consolidation, prior to going back to an upwards trend. Then, the price goes down again, forming the handle, and wither shoots upwards or downwards.

Sometimes, this cup will have a few particularly low support levels during the consolidation period. This is what causes the cup to form. You can see a cup consolidation happening in Bitcoin prices in late 2019 and early 2020.

cup and handle pattern
The cup and handle pattern is usually followed by a breakout, but it can also indicate a breakdown. Image by TradingView.

As you can see, the cup may not always be symmetrical. Cup and handle patterns also tend to form in more volatile assets, which is why they are more rare when trading regular stocks, but more common when trading volatile cryptocurrencies

How to Trade Consolidating Stocks 👷‍♂️

Now that you know exactly how consolidations look, it’s time to go through the steps to trading one. Keep in mind that a stock consolidation may not always end positively. 

Step 1: Find a Stock that is Consolidating 🔍

This may take some research, but start scanning stock charts and looking for those that are exhibiting one of the above patterns. You should be sure that the stocks you are researching are ones you are interested in owning, as there is no way to predict how long a stock consolidation will last. 

Step 2: Check the News 📰

Remember, consolidations almost always end in a breakout, which is a steep upwards, or downwards trend. This could be because of announcements the company has made. Stock consolidations can also happen when the company is experiencing something negative.

A prime example of this is the Disney consolidation pictured above. Disney experienced a decline in price, a consolidation, and then an even steeper decline. This is likely because of the resurgence of the COVID19 pandemic which happened in November 2021 causing Disneyland Hong Kong to shut down. This is something you would only find out by keeping up with news.

Step 3: Check the Trading Volume 🕵️‍♂️

The reason you are trading consolidations is because you are trying to make a profit. One thing you can do to maximize your profit is look for stocks that are experiencing a consolidation, but are showing an uptick in trading volume.

This indicates that although the market has cooled off for the time being, it is highly likely that the stock will begin trading again soon, and typically an increase in trading volume indicates a positive breakout in which the price will rise. 

Step 4: Consider the Length of the Consolidation 🧐

Consolidations don’t happen overnight, and it can be difficult to spot one that hasn’t been going on for awhile. But chances are, if you are noticing a consolidation, so are other traders. 

When you spot a consolidation that has been going on for a long time, there is a good chance that a breakout will happen soon, mainly because other traders will begin buying in as the consolidation continues. 

For example, the cannabis industry experienced a consolidation during the end of 2021 due to some market and supply chain issues. But as the consolidation continued, investors began to buy in, anticipating a breakout where the cannabis industry would overcome the issues and have a positive breakout. 

Step 5: Check the Width of the Consolidation 🎛

Take a look at all the above consolidation patterns. The one thing they all have in common (besides the strange cup) is that they end at a point where the support and resistance levels meet. 

This means that as the support and resistance levels get closer together, or as the width of a consolidation decreases, that a breakout could be imminent. This could be a good time to buy a stock that is consolidating.  

Step 6: Decide When to Buy in ⌚

By this point, if you’ve analyzed all of the above steps, it’s likely that you are ready to buy in. You now have two choices, you can buy in sometime soon, or wait for the retest—this is when a price returns to its previous levels after a breakout or breakdown, sort of “testing” the previous support or resistance level once again.

Sometimes, when stocks experience a breakout, it’s a false breakout, and the stock will settle back to where it was before. If you want to wait until the retest, you will wait to buy in until after a false breakout (if it happens). Just know that false breakouts are difficult to predict. 

If you don’t want to take this risk of missing a breakout, and you are sure that you have found a consolidation you want to invest in, you can buy immediately (if you think a breakout is imminent) or you can wait for a bit and see what happens in the consolidation. This is completely up to you. 

Step 7: Decide When to Exit 🏁

The final step of trading a stock that is consolidating is to know when you will exit. Are you waiting for a breakout? Or just for the price to reach a certain amount? 

Whatever it is, decide this now, to confirm your trading strategy. It is also a good idea to set stop-loss orders in case you are wrong about the breakout in order to minimize your losses. 

Conclusion 💭

If you’ve made it this far, you should have a pretty good idea of how you can trade stock consolidations to earn a profit. Just remember that a stock consolidation on it’s own isn’t a positive or negative sign, and that stock consolidations require a lot of research to be able to trade.

But if you don’t mind searching stock charts for breakout and breakdown consolidation patterns, you may find that trading consolidating stocks is fun. And you never know when you may find the perfect consolidating stock that is about to experience a breakout! 

Stock Consolidation: FAQs

  • How Long Can Stocks Consolidate?

    Stocks can consolidate for any length of time, sometimes for as little as a few days, to a few weeks, and they may continue to consolidate for years. 

  • Is Stock Consolidation Bad?

    Stock consolidation is a normal part of the lifecycle of a stock. It isn’t always bad, it just means interest in the stock is changing and the stock should be researched further. 

  • Why Do Stocks Consolidate?

    Stocks consolidate as part of their natural lifecycle as traders begin to lose interest in trading a specific stock. Think of stock consolidation as a cooling off period for a stock.  

  • Do Stocks Go Up After Consolidation?

    Stocks can go either up, or down after a period of consolidation depending on if it is a breakout, or breakdown consolidation. 

  • How Do You Know if a Stock is Breaking Out?

    You will know a stock is breaking out when there is an increase in trade volume as well as an increase in volatility of the stock in question. 

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