A Case Study In Consolidation: Chipotle

Chipotle Mexican Grill, Inc. CMG was recently in the news for jacking up prices, with analysts seeing logic in it, given ballooning expenses.

Stock Moves Out Of Range In Mid-April

Meanwhile, the investment community has become slightly optimistic on the shares, as reflected by the rally seen since late March, taking the stock to a new 52-week high. The stock was largely range bound between $370 and $450 until mid-April when it moved out of the range.

For the past one-year, the stock is up 6.74 percent.

Source: Y Charts

A Technical Take

The recent rally has put the stock in overbought zone, as reflected by the 14-day relative strength indicator rising to 79.60. That said, the sentiment is still positive, given that the shorter-term 50-day moving average (currently at $429.13) continues to remain above the longer-term 200-day moving average (currently at $410.96) since the former broke above the latter in early March.

Source: Y Charts

If the stock doggedly pushes forward, it could face serious resistance around the $511–$533 area, a peak last scaled before the recent consolidation began in April 2016.

Consolidation Phase

Consolidation, according to Investopedia is used to refer to the movement of a stock price within a well-defined pattern of trading levels.

A consolidation phase, a phase in which a stock moves sideways, can last for days or months, or even a year or two. In the case of Chipotle, the trading range was sustained for about a year. It usually represents a narrow trading band, within which there could be short rallies or retreats.

Essentially, the stock is moving to an established low and then rebounds to an established high and then repeats this move, without breaking below the established lows, termed as the support, and above the established highs, termed as the resistance.

Another way of looking at it is that it represents a period when traders are indecisive about the next price move and they stay positioned for the next move.

For confirming a consolidation phase, look for:

• Steady support and resistance levels.
• The trading range has to be narrow.

Consolidation: A Healthy Trend?

Experts view consolidation as healthy. If a stock continues to run up without any consolidation, it may prompt investors to be wary of any dip, resulting in largescale liquidation at the first sign of a pullback. In this case, the percentage by which the stock retreats could be far more than the pullback associated with a consolidation.

How To Trade Consolidation Phase

To trade a consolidation move with higher profits and less risk, traders need to look at volumes.

Volumes during a consolidation phase are generally low. When a security is approaching the support/resistance level, there is usually a pick-up in volumes. Especially when a security is about to break out, volumes increase more than the normal levels.

Traders can position themselves to buy a stock when it breaks above the resistance levels or sell a stock when it violates its downside support.

Once identify a breakout candidate is identified, confirmation of the breakout needs to be established by looking at volumes. Subsequently, one needs to set a reasonable objective, which can be done by measuring the distance between the support and resistance levels.

However, if the stock retests its previous resistance or support levels, then the breakout can be deemed as having failed. It is advisable that an investor exits by taking a loss.

Going by the volume trend, Chipotle's current breakout may not point to a sustainable upward move. Caution could be the watchword, even as investors go gung ho above the stock hitting its highest level for the year.

At the time of writing, Chipotle Mexican Grill is slipping 1.20 percent to $473.03.

Related Links:

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Why The Chipotle Bull-Bear Debate Is Focused On Comps