Consolidation is a term which is mentioned in financial sections of newspapers and TV channels. Have you ever wondered what consolidation is in the stock market?
What is consolidation?
Consolidation refers to the range bound movement of a stock. During the consolidation phase, a stock doesn’t show any major price movement and stays stagnant. Consolidation is also sometimes called a time-wise correction.
When the stock is in a consolidation phase, it doesn’t move significantly higher or lower than its current market. This sideways movement causes an investor to not lose any money, but instead causes an opportunity loss because the price remains same with the passing time. This is why stock consolidation is also called time-wise correction because the investor loses value over time by staying invested in the stock.
There is generally an upper limit and a lower limit in which the stock remains bound for a period which can last for days, weeks, months or even years! The stock gets out of the consolidation phase in one of two ways – either the stock breaks the upper limit and starts its uptrend or the stock breaks the lower limit and starts its down trend.
Why does consolidation occur?
The consolidation phase of a stock occurs after a bull run or a bear run. Post the completion of the trendy movement of the stock (either in uptrend or in a downtrend), a stock enters a consolidation phase when the market becomes indecisive. Consolidation is the outcome of the indecisiveness of the market which causes the stock price to ping-pong between an upper and lower limit.
Once the stock has entered a consolidation phase, nobody can predict the time limit for which the stock can stay within the consolidation phase. There are many examples of stocks which have stayed in a multi-year consolidation and gave zero returns to its investors such as Reliance Industries (consolidated from 2011 to 2017) and Hindustan Unilever (consolidated from 2015 to 2017).
Is consolidation good for a stock?
Generally speaking, consolidation is considered to be good for a stock. Stocks which do not consolidate post a bull run tend to rapidly fall thereby eroding the wealth of the investor. Typically stocks which consolidate after a bull run have a much healthier rise to the top.
From a long term investor’s perspective, consolidation is almost always considered to be good for the stock. A consolidation can be considered to be an acknowledgement that the market accepts the current price of the stock to be fair. A stock which is consolidating provides a good opportunity for the long-term investors to enter the stock without any worries of a trend reversal. A growing company with a consolidating stock is always a good investment opportunity in the long term!
From a stock trader’s perspective, a stock which is consolidating should be completely avoided. Stock traders rely on the volatility of the stock which helps them to make money in the market. A stock which is consolidating doesn’t have any major volatility which makes it a bad choice for a stock trader. Such a stock is not worth the time & effort for a stock trader.
Conclusion
Consolidation phase is an inevitable part of a stock’s journey. It is considered to be healthy for the stock because it validates that the price of the stock is considered to be a fair price by the market. Consolidation is typically followed by a breakout or a breakdown which sends into a bull run or a bear run respectively. Long term investors can create fresh positions during the consolidation phase of the stock. On the other hand, traders should stay away from the stock during the consolidation phase. However, the final decision of investing in a consolidating stock depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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