Consolidations don’t last forever

I’ve often noted on this blog and in my various media work that consolidations –defined as “trendless” zones of no new highs or lows—eventually lead into powerful breakout moves. Which side of the consolidation (upside or downside) the breakout occurs dictates which way this powerful follow-up move will be.

You can prove this observation for yourself by pulling up any chart of a market or well traded stock (daily charts are best) and observing the action after a period of consolidation. A breakout usually leads into a quick and strong movement. This is why I usually advocate waiting to buy on a positive breakout before jumping into a stock that is consolidating.

Today, I’ve posted a daily chart of the S&P 500 going back 3 years. You can see where I’ve marked consolidation zones—that is, zones where the market stopped making new highs. These zones can result in bullish breakouts leading into impressive rallies – such as the breakout in June 2014 (far left side of chart). Or, they can break to the downside and lead into a sizeable correction—as happened August 2015. The point is – consolidations are neutral – until proven bullish or bearish upon a breakout. As you will note on the far right hand side of the chart, we are in the early stages of a period of consolidation. So far, it’s been about a month since the S&P 500 made a new high. The trading range is pretty tight right now.

While the market consolidates, you really can’t make too many bold predictions. Will it breakout to the upside or downside? Both are possible, but I’ll venture a guess that we might see a selloff into late January and into February which could see a revisit of 2230 December low point – or thereabouts. Should that low point break—and stay below 2230-ish for a few days, we might be in for a more substantial correction. That’s because it might suggest a break of the current consolidation pattern we’ve been in for the past month. Conversely – an upside break through 2280-ish that lasts a few days might be signs of a nice rally to come. Either are possible –my bet is for a brief visit downward before an upside breakout later in the winter. We shall see!