How to Spot a Breakout Through Consolidation

Feb 01, 2021 | Understanding consolidation is vital for any swing traders

Understanding Consolidation is Vital for any Swing Traders

Now more than ever, it’s important to identify trends when investing in stocks. As traders, it’s vital to not only read and interpret the market but to actively look for trends in a stock’s price chart. One common trend analyst’s look for is consolidations. Understanding consolidation is vital because it can help identify a breakout, or a rapid movement in a stock’s price.

What is Consolidation

Consolidation is a term used to describe the movement of a stock’s price. Consolidation occurs when a stock price is struggling to breakout of its current price range. You can identify a consolidation trend when:

·       A stock’s price has demonstrated a clear horizontal pattern

·       Stock price continues to stay within a contained threshold

·       Support and resistance lines have been clearly established

Stocks demonstrating a consolidation trend may stay in the same price range for weeks or even months. Consolidation trends can be difficult to interpret because they may leave traders with very little opportunities to buy or sell a security.

Spotting a Stock in Consolidation

How do we know if a security is demonstrating a consolidation trend? It can be tricky because as we’ve already discussed, periods of consolidations can go on and on and on. Here are some helpful tips for spotting a stock consolidation:

1. Significant Movement in Stock Price: Whether a security’s price has recently moved up or down, large price shifts in either direction tend to result in a period of consolidation. After a stock’s price has made a drastic move, it’s common to see a ‘cooling off’ period to allow for new trends to form as trader stake profits or cut losses.

2. Changes in Trading Volume: Do you consider trading volume when deciding on a trade? Large swings in trading volume can happen for a variety of reasons, but it’s important to note them and identify the changes when considering any trade.

3. Consistent Support and Resistance: When looking for trends to help identify a consolidation, you want to look for strong support lines. You’re looking for a stock that continues to trade within a certain price range. Ideally, this price range would be shrinking and getting tighter and tighter.

4. How long has the stock been consolidating? The longer the consolidating trend, the more data we have as investors.

Careful: Be sure to not hastily declare that a stock is in consolidation without looking at the timeline on the charts.  Stocks that have only sat in their identified price ranges for a few days are not in consolidation, at least not yet!

       This graphic represents an example of a stock in consolidation. Note how it clearly establishes the resistance and support line.

Remember our Learning Points

The more likely a stock will breakout of either its resistance or support lines, due to:
1. The more narrow a stock’s price range
2. The higher the volume
3. The longer a stock consolidates

Weekly Swing Trades

PNRG (Prime Energy)

October 2, 2022

Entry Price:

80.62

Stop Price:

76.85

Target Price:

88.04

Time Frame:

1 Week Hold

Expecting a short-term bump after a recent OPEC+ announcement regarding the a supply constraint to oil. The constraint would result in ~1M less barrels of oil per day, which should cause a price jump. Low RSI and bouncing off our 250 day moving average, both hallmarks of a good swing trade.

DV (Doubleverify)

October 2, 2022

Entry Price:

27.75

Stop Price:

26.75

Target Price:

29.00

Time Frame:

3 Week Hold

Using our moving averages heavily on this swing trade, look for continued strength as we try to notch out a 6-8% gain. Specifically, we are taking advantage of of a recent cross over in the 50 day moving average. Last week closed down, so wait for confirmation of a reversal.

Stock Breakouts

·       A breakout occurs if the price of a security has extended past and beyond the range it had previously been sitting.

·       When a stock breaks out of the price range it was struggling to move past, a larger shift in price may be coming.

·       Breakouts are critical because they can lead to large gains or losses in very little time

       Notice how a consolidation occurred after the initial breakout out, which led to another breakout shortly after.

False Breakouts

When trading stocks, it’s important to also recognize a false breakout when you see it. A false breakout occurs when a stock moves above or below their key resistance and support lines but only for a brief amount of time. When a false breakout occurs, the stock price tends to quickly retreat to the same price range it was originally struggling to breakthrough. A false breakout could mean there wasn’t enough interest in the stock to keep the momentum going, whether it be positive or negative. Again, another key indicator when spotting a false breakout is trading volume. It’s difficult for a stock price to make any significant price swings when the trading volume is low.

Common False Breakouts

It’s important for any trader to tell the difference between a breakout and a false breakout. Though the stock may move outside of its consolidated price range briefly before returning, this movement is considered a ‘continuing pattern’ and may not always be reliable.

Rectangle

o A chart pattern that is formed when a price is bounded by parallel support and resistance lines.

o Rectangles aren’t hard to spot. Due to their popularity, rectangles can be very vulnerable to false breakouts.

o During a rectangle trend, the market is considered very indecisive and traders should beware.

 

Bearish Rectangles

o These chart patterns occur when the consolidation range is getting squeezed and the stock’s price range is beginning to diminish.

o These rectangular consolidation patterns may occur while the stock is trending down.

o Even if the stock is taking a breather while the new trend forms, it’s important to be aware that the security has slowly been showing patterns of a downtrend.

 

Bullish Rectangles

o  These patterns are visible when a stock’s price range is slowly rising.

o  These patterns can be indicators that the security is on an overall uptrend.

o  This could potentially signal an opportunity to buy or trade the stock.

Trading Breakout Stocks

1.     Have a Plan: As with any form of investing, it’s vital you have a plan. Know your thresholds, establish your own risk appetite and set your buy sell triggers or parameters. And don’t forget, when making any investment plan, hold yourself accountable!

2.     Find Your Opportunity: We’ve talked extensively about how to spot a breakout and the importance of understanding consolidations. Don’t forget, volume and time are key when looking for any potential gains through a breakout. As they say, patience is a virtue.

3.     Know When to Cash Out: A key point to remember when trading breakouts, change is imminent, and it can come out of nowhere. The longer a stock trades within a consolidated range, the higher the probability of a breakout occurring.  

Summary

When investing, it’s so important to look for trends within the charts. This is especially true when trading! Stock consolidations are a key pattern we should all be on the lookout for. Consolidations may be an early indicator of a pending breakout. If a stock has been trading within a narrow price range for an extended amount of time, a breakout may be close by. Breakout’s can lead to significant movement in a stock price in very little time. Breakouts can lead to large gains OR losses very quickly. But with the right plan in place and the ability to spot a real breakout from a fake imposter, we increase our chances of being on the right side of a stock’s breakout!

We are building a new FORCE within the trading community! One built on knowledge sharing and collaboration from an extremely diverse background of professionals hailing from all walks of life. As both a community and a club, we’re a passionate about trading and gaining consistent profits together!

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Market Performance- Week of 09.25.2022

Recent Winners

SBUX (Starbucks)

SBUX (Starbucks)

Entry Price:

85.00

September 11, 2022

Price at High:

89.90

Return for Members:

5.76%

Timeline:

2 Month Hold

Strong momentum over the last few weeks. Watch for a mean reversion, but if moving averages stay consistent look for an early play to open the week.

PNRG (Prime Energy Resources)

PNRG (Prime Energy Resources)

Entry Price:

83.20

September 4, 2022

Price at High:

100.00

Return for Members:

20.19%

Timeline:

3 Week Hold

PNRG had a drawdown to historical levels of support (around the 100 day moving average). Looking to make an entry in the coming days as we also have macro tailwinds with the energy crisis in Europe.

PYPL (Paypal)

PYPL (Paypal)

Entry Price:

87.00

August 28, 2022

Price at High:

103.00

Return for Members:

18.39%

Timeline:

4 Week Hold

Playing off the dip in June, we're starting to see momentum as the 50MA is crossing over the long-term averages. Look to for momentum to continue and an early entry on Monday.

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