What is a Shakeout?
A shakeout is a situation in which many investors exit their positions in a stock or market segment at the same time, often at a loss. A shakeout is usually caused uncertainty or recent bad news circulating around a particular security or industry. Shakeouts can be quite variable in duration, but they are usually sharp in terms of the amount lost from recent highs.
A shakeout isn't a well defined term. Depending on who is using it, it can refer to a situation that sees consolidation or a situation where there is a severe correction. In broad market usage, a shakeout is simply a period of market turmoil that causes investors to pull back. Again, depending on who is talking, this situation can be described as a shakeout or a market selloff or a market correction. In technical analysis, however, a shakeout is better defined and is said to occur as a leading stock corrects in price.
When it comes to chart formations, there are a few patterns that are considered to be shakeout patterns. These include the cup and handle pattern and the double bottom. The market narrative for a shakeout is that periods of rising prices will eventually exhaust all the bears as well as all the interested sellers. In the absence of selling pressure, the price action carries upward beyond its moving averages and encounters resistance and dropping volumes. This halts the stock's advance and leads to a pullback. After the shakeout, the previous trend often reasserts. It is worth noting that shakeout is almost exclusively used to refer to an interruption in a longer term bullish trend.
Shakeouts happen all the time. During broad market events, like the dotcom bubble or the Great Recession, there are numerous shakeouts that see money pulled out of particular segments of the market. However, there is a related usage of shakeout that deals with specific industries. An industry shakeout is when a period of massive expansion is followed by consolidation. In this case, stronger companies use their capital reserves to acquire or eliminate weaker competitors that have overextended themselves.
This happens frequently with new industries, as with the dotcom bubble and the more recent rise and consolidation of social media companies. If the companies in question are publicly traded, then the industry shakeout is mirrored in a market shakeout. If, however, some or all of the companies remain private during their growth stage—something that is becoming more common with technology companies–then the shakeout takes place without involving retail investors and the broader market.