Consolidation At Previous Highs
Consolidation At Previous Highs
By Dave McLachlan
This is a phenomenon that is very useful to know. While it is simple (like all the techniques I tend to use) it is also powerful and extremely lucrative. It was also the basis for Nicholas Darvas’ technique in the book “How I Made $2,000,000 In The Stock Market”, published in 1961. I find that the simpler the better – after all the day is there to be enjoyed, not spent analyzing astrological charts or dozens of pages of company earnings.
So what is this phenomenon? It is that price tends to consolidate at previous highs. For example if price in a stock made a high at $55, corrected to $40 but then moved back up again to $55, you would find that price consolidates there in a sideways movement for a few days or weeks before moving on. Let’s check out a visual example of what is happening – click on the pictures below to enlarge:
The reason behind this is simple. Investors who have bought at the market bottom are now getting edgy and looking to sell – and the perceived resistance at $29 is the perfect place to do it. But of course we also have investors who are waiting for the stock to break into new highs before buying, and this is also the perfect place to do it. Buyers and sellers. Both frantically buying and selling. And what happens? Price stalls. It consolidates before moving on.
Once we know this we can use it to our advantage in the following ways:
1: We can be ready to buy once price breaks out from this consolidation.
2: We don’t have to be scared out of the market if price seems to stall – instead we can wait for a confirmed exit signal according to our rules.
Of course price will also consolidate at market lows – usually around natural support – before moving down. It is something we can use in up or down markets.
Previous Highs Aren’t The Only Ones
Price can also tend to consolidate around trend lines. In this way we can get consolidation at horizontal support and resistance but also at diagonal support and resistance levels, and both are good to be aware of.
There are certain things that happen with such regularity in the markets that they cannot be ignored. Things that truly put the “random walk theory” to shame. As always, please check it out for yourself – back-test a few stocks, notice the consolidations and practice trading with them. If they work for you, then great! It’s always nice to have another way to increase your wealth.
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July 29, 2009
Tags: Enter and Exit, Market Basics, market consolidation Posted in: Articles On Building Wealth
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