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Innings under Consolidation

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After the sharp fall witnessed in the first month of the new year, the Indian benchmark indices for the last few weeks have been consolidating in a range.

The moves in such consolidation have been very sharp and swift.

The idea of a rangebound market is a difficult one to comprehend in terms of a trader’s point of view, because in such cases he is likely to lose more money than in a trending market. Ideally for any ‘trader’ in such markets, with each losing trade the trading capital has to decrease, but as the human feeling of inevitability grows, the size of the bet goes higher.

It is however noteworthy that there are always three types of trends in the market, uptrend, downtrend and consolidation. Yes, consolidation is also a trend in the market.

Let us take a closer look at consolidation pattern: After a sharp trend in the market,(either uptrend or downtrend), the markets likely fall into consolidation. Now why does this happen.

Generally as the market witnesses a sharp rise/fall in prices, there are a lot of new investors and traders who enter into the market and with each win their bet goes higher and higher. After a critical level has been attained by the market, either in terms of a new resistance being broken, or a new support being breached, the sentiment just intensifies and we see a flurry of activity in select stocks and indices. At every breach of a support or a resistance, the activity intensifies, because there a number of stop loss orders for shorts or longs, respectively, which gets triggered, and investors are looking to exit and book their losses. However, there are a section of investors who have a slight different perspective in such times. They believe that either the market is highly overvalued or highly priced in a rising trend or they are of a belief that the stocks have been hammered to pulp, and that this is a strong level to start nibbling in from a longer term perspective. Either case will lead to a strong bout of volatility in the market, with the markets trying to find a suitable top or a bottom.

The type of consolidation also differs in different market conditions. For those who trade on breakouts or breakdowns, their portfolio becomes subjected to a lot of whipsaw, as markets either have a contracting range of a expanding range during consolidation.

Also in such range bound markets, the technical indicators generally provide a mixed picture of the markets, hence I believe that the best way to sail through such times is to trade light, and nimble. Adhere to the stop losses and trade only liquid stocks. In falling markets liquidity generally diminishes thereby making it difficult for the investor to exit his full quantity of stock at lowest impact cost.


Written by Kunal Bothra

March 14, 2011 at 1:12 pm

Posted in Market Watch

Tagged with , , ,

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