What is a “shake-out”?

I throw out the term shake-out a lot, so many novices ask me to explain the term. Here goes …

Market psychology and how it manifests itself in charts is an essential part of understanding and being successful in the markets.

The term “shake-out” is a stock life cycle term. Investors buy a stock with expectations. The usual expectations of steady or rapid price growth. But stocks get stuck in ruts and cycles. Delays in new product releases or unexpected competition are things that jump in the way and cause expectations to not be met. Stock prices then languish in the doldrums. Long-time shareholders become disgruntled and want to move on to a new market opportunity.

These shareholders that have lost faith are looking for an exit strategy. Some “just want their money back,” while others want to exit at any cost. The problem is that every time good news brings new investors into the stock, the old shareholders use these uptick prices to unload more of their holdings.

Despite the good news, the stock price continues to slide downward as more old shareholders sell into these opportunities. This is the shakeout phase.

But eventually, all of the old shareholders get shaken out of the stock. The only shareholders left are optimistic ones, more likely to hold the stock through the medium or long term. Suddenly, the downward pressure on the stock is lifted. The stock price starts to rise, often rapidly. New money pours into the stock, bidding prices even higher.

This is the phenomenon known as a shakeout. It’s best exhibited in the classic cup and handle stock chart formation. On good stocks, in good market conditions, it often results in major break-out price movements. 

Look for these cups and handle chart patterns forming. They are a very profitable pattern to invest in.

D.A. Campbell

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