How to Spot and Trade a Consolidation Phase

I’ve mentioned several times recently that January is one of if not the best month for trading, as the whole game changes with the start of a brand-new year…

So I want to focus this piece on something more macro I see affecting the market for the foreseeable future regarding the market making a real move higher. And it’s a great chance to teach everyone how I read charts…

Be sure and tune in on Tuesday as well, because I’m going to break down Tesla Inc. (Nasdaq: TSLA) from a technical standpoint and discuss whether or not now is a good time to buy — because this stock is big time beaten down.

Heading into the end of the year, when people are looking at their losing positions like… 

“I’m sick of looking at this stock! I don’t want it on my books anymore. I’d sell in a heartbeat if I could get just 5% more for it.”

And as long as that is the mass psychology of Wall Street, we’re likely to have overhead resistance — a wet blanket — that’s hard to break above, allowing stocks to make that meaningful move higher I mentioned above.  

And that brings me to the S&P 500, which is in a consolidation phase right now. That simply means it’s moving sideways with no directional bias since mid-November. Check this out…

It closed just above its 200-day moving average on Dec. 13, the upper gray line in the chart above. And whenever you see it stuck between two moving averages like that — the lower gray line is the 100-day MA — that’s a strong consolidation pattern with a channel that’s getting more and more narrow.

And here’s the thing… When you leave a consolidation pattern, you generally go hard in one direction or the other — up or down.   

If we get a decisive move above 4,100, then odds are we can get back to the summer high above 4,300, the horizontal upper pink line in the chart above. 

If we break below that range of 3,930 or so, then odds are high we’ll get a lot more downside. So it’s 50-50 if we go higher or lower, but the downside move is more interesting to me…

And that’s because there’s more space to go down — to around 3,500, the lower pink line — than there is short-term upside, and gaps are made to be filled…

There’s a similar pattern going on the Nasdaq, but it’s decisively more bearish than the S&P 500 since it’s trading below the 100- and 200-day MAs…

Now, I don’t trade the Dow because there are no futures on it like the S&P 500 and Nasdaq, and it’s a small, arbitrary group of just 30 stocks… But it is by far the most bullish chart of the major indices…

The question is why does it look so much more bullish? Once you take a look under the hood at the best and worst stocks of the Dow, it becomes more clear…

The Best & Worst Dow Stocks Year to Date (Through Dec. 14)

  1. Chevron Corp. (NYSE: CVX): +47.35%.
  2. Merck & Co. Inc. (NYSE: MRK): +45.45.
  3. Travelers Cos. Inc. (NYSE: TRV): +20.84%.
  4. Amgen Inc. (Nasdaq: AMGN): +20.83%.
  5. Caterpillar Inc. (NYSE: CAT): +14.76%.
  6. IBM Common Stock (NYSE: IBM): +13.24%.
  7. Coca-Cola Co. (NYSE: KO): +8.95%.
  8. UnitedHealth Group Inc. (NYSE: UNH): +7.98%.
  9. Johnson & Johnson (NYSE: JNJ): +5.66%.
  10. Honeywell International Inc. (Nasdaq: HON): +4.22%. 

Chevron is an Energy sector stock — the best sector in the market this year — and the biggest winner in the Dow… Merck is riding the big pharma wave because of COVID-19 and the recent cancer vaccine news with Moderna, its partner in that endeavor… Amgen is a biotech name… Caterpillar is an interesting industrial name… Honeywell is a conglomerate with exposure to U.S. contracts…

But if you look at the dogs of the Dow…

  1. Home Depot Inc. (NYSE: HD): -18.47%.
  2. Walgreens Boots Alliance Inc. (Nasdaq: WBA): -20.90%.
  3. Cisco Systems Inc. (Nasdaq: CSCO): -21.13%.
  4. Microsoft Corp. (Nasdaq: MSFT): -22.46%.
  5. Verizon Communications Inc. (NYSE: VZ): -27.35%.
  6. 3M Co. (NYSE: MMM): -27.77%.
  7. Nike Inc. (NYSE: NKE): -32.14%.
  8. Walt Disney Co. (NYSE: DIS): -38.65%.
  9. Intel Corp. (Nasdaq: INTC): -43.82%.
  10. Salesforce Inc. (NYSE: CRM): -46.09%.

Disney is a surprise dog, but I wouldn’t buy it yet because I think it has a host of problems… Salesforce is one of our shorts in Money Flows Elite, and it’s the worst stock in the Dow this year…

Now compare these to the worst stocks in the Nasdaq — which are far more sensitive to higher rates like we’re constantly getting from the Fed now — and it’s not even close which ones have suffered most. The worst of the Nasdaq stocks have gotten crushed…

  1. Tesla Inc. (Nasdaq: TSLA): -55.56%.
  2. Zoom Video Communications Inc. (Nasdaq: ZM): -59.52%.
  3. Docusign Inc. (Nasdaq: DOCU): -60.16%.
  4. Atlassian Corp. (Nasdaq: TEAM): -60.79%.
  5. Zscaler Inc. (Nasdaq: ZS): -60.95%.
  6. PayPal Holdings Inc. (Nasdaq: PYPL): -60.99%.
  7. Meta Platforms Inc. (Nasdaq: META): -63.55%.
  8. Match Group Inc. (Nasdaq: MTCH): -64.98%.
  9. Align Technology Inc. (Nasdaq: ALGN): -69.59%.
  10. Lucid Group Inc. (Nasdaq: LCID): -79.50%.

After seeing how much these Nasdaq stocks are down by comparison to the Dow’s worst, I think you guys get the idea why the Dow looks so much better right now… And why looking at opportunities to the short side, to me, are a lot more appealing and exciting IF the market does indeed head lower, which it did immediately after the rate hike announcement on Wednesday. 

This is how pros look at trading from a more macro perspective, and I hope it helps you understand a bit more about how I approach things. 

In this kind of environment, I like to short the terrible stuff… And if and when I can go long with bullish stuff that meets my criteria and systems, then I do that, too. 

But to be a cyclical trader is a dangerous way to go in this kind of market in the near term — meaning if you’re making money decisions in hopes of a Santa rally, I’d be careful… 

When it comes to trading, we all have our own systems. And my boy Lance Ippolito is the best of the best when it comes to unusual options activity. And he’s about to teach a class on how to spot the next big trade for yourself…

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*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.