Is This Consolidation Normal?


consolidation - Is This Consolidation Normal?

The market was led lower by Facebook, Inc. (NASDAQ:FB) this week following allegations that customer data was released to commercial firms and political consultants without the knowledge or consent of the users. It’s not the first time we have seen something like this, and it seems unlikely that it will be the last, but investors anchored on the news and sold the entire sector (and market indexes) lower.

Following a recommendation from famous Legg Mason Inc (NYSE:LM) investor Bill Miller, FB was on the rise again on Wednesday. The FB recovery then combined with a surprisingly bullish oil inventory report to send the indexes higher overall. However, as of this writing, it’s too early to say for sure how long the major indexes will remain positive because the Federal Open Market Committee (FOMC)’s announcement will still take a while to really work its way through the market.

The Fed’s announcement on Wednesday may wind up helping the market break out of its consolidation. The benchmark overnight rate was raised by a quarter-point, and expectations were set for an accelerating rate of hikes in the future. The statement released with the announcement was particularly bullish (from an economic perspective), and investors used that as an excuse to bid the market a bit higher into its current range.

The question we started with in the title of this article has an easy answer: Yes, this consolidation is normal. It is hard to prove that Facebook was the primary catalyst for the decline over the last few sessions, but it seems very likely. This kind of systemic reaction to non-systemic news (FB’s data problems) is typical during the consolidations that occur after corrections like the one we saw in February.

On average, post-correction consolidations last about six weeks. However, because there is so much variation in the market, it would be more meaningful to say that consolidations tend to last four to eight weeks. In that sense, this one is in the normal time-frame range and has had a bullish bias so far.

As you can see in the following chart, the consolidation has essentially been a “rising wedge.” Unfortunately, we are still in “pre-breakout mode,” which means fakeouts and whipsaws are more common than normal.

S&P 500 (SPX) Daily — Chart Source: TradingView

The Bottom Line

As long as we are in a consolidation range (wedge), it won’t take much news to push the market one direction or the other for a few days. On Monday, it was FB sending the market lower, and Wednesday’s bullish behavior (and subsequent whipsaw) was likely due largely to a bullish oil inventory report and the Fed making an entirely expected announcement that it would hike the overnight rate by a quarter-point.

This is the nature of a market that is relatively balanced between buyers and sellers. It won’t take very much to upset that balance to the upside or downside. This can be a frustration for option traders because we tend to lose time-value during consolidations, but we want to maintain exposure to capture the eventual breakout, which can be extremely profitable.

You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.

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