Consolidation or Distribution.

Rakesh Sethia asks “In the previous blog, we talked about the cycles – expansion and contraction. To extend the topic, how can we identify if the contraction is a consolidation or a distribution? what are the features and distinguishing points classifying them so”

My Notes: This is an interesting question. I find it so because the answer to this question should be actionable for traders.
There are no rules as such for distinguishing between consolidation and distribution. I have some thoughts on this subject which I will share with readers here. Please do not memorize them, do not convert them into rigid formulas. And, please do not come back and say “you said such and such should mean consolidation but it was distribution.” My point is: these are just my thoughts, and, there cannot be any rigid set of rules since the markets themselves are dynamic.

1. Where are we in the market cycle? The cycle consists of four phases – Accumulation, Run up, Distribution and Markdown. If the run up phase has been going on for long, then maybe this is a distribution.

2. Pending Targets: If there is a technical target that has not been reached, chances are that the contraction is a consolidation before another breakout takes us to the target.

3. Contraction in a narrow range: The process of contraction will normally start in a narrow range, then expand to increase the range. An expanded range can go either ways. But, if the initial range of the contraction more or less remains the same, while the number of bars in the contraction increase, then the chances are that this is a consolidation with prospects of a big, sudden breakout.

4. Patterns inside contraction: Sometimes, we observe the development of a predictive pattern inside a contraction. This can come about in the same time frame or lower time frame. Patterns can be an indication of which way the contraction may breakout.

5. Intra day rewards: While markets move inside a narrow range, often, the intra day trades are rewarding one group of traders – bulls or bears. This is the first sign of which way the contraction may breakout.

I am obliged to readers for contributing to this blog with their thoughtful comments. Please continue to do so.