Consolidation in the stock market is another important term that a trader or investor must know to take advantage of various trading opportunities. The term consolidation refers to the stage when the given stock or index trades on the defined price bracket. Its price neither goes too high nor too low, but when the price is broken, the stock can be ready to take a bigger move.
Read this article to learn more about consolidation in the stock market, its patterns, ways to conduct consolidation trading, and other crucial terms that will help you take advantage of these trading opportunities.
What is Consolidation?
Consolidation in the stock market means a condition when stock trading happens with a small or limited price bracket; it neither continues nor reverses based on trends. Also, it provides very limited trading opportunities as the stock price fluctuates with a limited price range.
In other words, stock consolidation is the stage where the stock and index trade takes place with a limited price range. The trend or stock price movement falls under a set pattern that doesn’t rise too high or fall too low. Generally, this range is between support and resistance levels decided by trader indecisiveness after considering other factors.
Example of Consolidation
Below we have provided an example of consolidation in trading.
Mr. Ramesh holds 1,000 shares of ABC Ltd at Rs 100 each. So, when the consolidation ratio becomes 1:5, the five shares are treated as 1. Mr. Ramesh’s 1,000 shares will be reduced to 200 shares, but the total value of holdings (shares) remains the same.
Value of 1,000 shares held by Ramesh (Before consolidation): 1,000 x 100 = 1,00,0000
Value of 200 shares held by Ramesh (After consolidation): 200 x 500 = 1,00,000
There may be some trading scenarios where the shareholders may leave with a unit of stocks lower than their actual holdings. This mainly happens due to reverse stock splits or consolidation of shares. When shares are consolidated, these shares are called fractional shares.
The company appoints a trustee to purchase these fractional shares because these shares are not available in the market. When the trustee purchases these shares from shareholders, the proceeds generated from this trade are deposited into the primary bank account given by shareholders.
How to Find Stocks in Consolidation?
If the stocks are met with the below-mentioned conditions are said to consolidate.
- The selected stocks have a defined price range and steady resistance and support level, which create flag-like patterns in the stock chart.
- Another condition is that there must be a narrow trading range.
- The third condition is that the volume of selected stocks will be low, and there will not be any spikes.
Note: Stock consolidation refers to the movement of market indecision if there is no change in the stock price level. There is either an upper or lower trend in the price of the selected stock. Additionally, when the stock price limit range is broken, traders can see strong price movement of fractional shares.
What Happens Once the Consolidation Period Completes?
Stock consolidation mostly leads to a strong breakout once the consolidation period completes. If the trader thinks the previous trends were proper, the breakout trend keeps taking place. However, if traders decide the previous trends are incorrect, the stock witnesses a reversal breakout.
Thus, when trading in consolidated stocks, it’s essential to carefully analyze the stock trends and confirm that there are breakout trends. You can use technical analysis techniques like moving average convergence divergence or relative strength index methods.
What Are the Patterns in Consolidation?
Below are some patterns that may occur in consolidation; look at those to gather insights.
Wedges Pattern
This stock consolidation pattern shows that the price bar lies between two trend lines, either upward or downward. However, the trend line often has a higher slope than other stocks. Mostly the price swings between the trends and becomes smaller as they pass through. There are two types of wedge patterns such as rising and falling wedges.
Triangles
This pattern has three types, including ascending, descending, and symmetrical triangles. Ascending triangle patterns occur when there is the possibility of drawing a horizontal line between the swing highs and the rising trend. Descending trend is totally the opposite of an ascending trend that is constructed when you join the lower highs with the trend lines. The symmetrical pattern occurs when the pattern is created if price movement makes two assembling trends with the given slope.
How to Start Trade in Consolidation?
If you trade carefully in consolidation trading, you can make good gains. Below are some crucial tips to remember when doing consolidation trading.
Minimize Trading Limit
As there is no strong price movement, it’s better to reduce the amount of investment. It will avoid any loss if you make the wrong decision. If you are a day trader, decide on investment value that you can achieve during the day trading only. For example, you can choose the call option with less strike rate and put it with a higher strike rate.
Spreads Instead
It’s another option that makes your trade easier. You can trade in spreads instead of buying a single option. The spread consists of a higher strike price for call selling and a lower strike value for put selling.
Maximize Prudence Level
If it’s clear that your selected stocks are in the consolidated phase, it’s time to optimize your profit by exiting a bullish trade close. When there is no open trade option, wait until breakout trends confirm.
Conclusion
Stock consolidation in trading is a must learn thing for stock traders and investors, especially when you participate in day trading. You can make good gains even during day trading by making the proper use of technical analysis and further trading trends. However, there are limited opportunities to profit from consolidation in the stock market. Therefore, one must be aware of various trading terms, trends, techniques, and other resources to make the most of this trading technique.