How To Get Early Entries Into Winning Stocks
A key
component of intermediate-term trading is the base. From
the base come all good trades in this strategy. This lesson explores base
counting as a method to gauge where a stock might be in its life. Typically, a
strong stock will form several bases before topping out. The stocks will also
trade in similar fashion to the overall market. From what Mark
Boucher and his indicators
have been telling us lately, we may very well be at the beginning of a new bull
run. Taking a look at the bases of individual stocks will keep us ready to act
when the time is right.
An ideal base for the
intermediate-term trader will be at least seven weeks long. For the base to
properly trigger a pivot buy point, the price action must trade on high volume
10 cents above its most recent consolidation. This is most often in the
formation of the famed cup-with-handle pattern. If the breakout is good, and the
stock is able to move at least 25% above its pivot buy point without first
trading lower than the base, a new base can form. Counting bases is most easily
done when analyzing weekly
charts.
How The Bases Stack
Up
A strong stock in its
first base is usually at a point where the company is quietly doing its thing,
and little attention is paid. As the company continues to produce superior
earnings, its popularity increases and successive bases are formed. When the
masses finally catch on, the stock is often into its third base or higher, and
weakness is evident in the formation.
When a stock finally
tops out, it will typically occur at a time when the company is being profiled
on the covers of popular magazines, and being touted as a “must own.”
As the masses pile on, the price runs up, and ultimately the buying
pressure exhausts itself, making way for the sellers. Not all stocks are strong
enough to make it into late-stage bases, and it is very rare for a stock to move
past fifth and sixth bases. Sell-offs in top stocks will often occur when the
market is declining as well. The
examples used for this lesson all contain intermediate-term selections that
faltered in their later-stage bases. The final example shows a situation in Oracle
(
ORCL |
Quote |
Chart |
News |
PowerRating) where the base counting is reset after the stock trades below its
base.
Example 1:
(
AMGN |
Quote |
Chart |
News |
PowerRating)
This chart shows Amgen
(
AMGN |
Quote |
Chart |
News |
PowerRating) in its run from 1998 into 2000 as it formed four bases.
Notice how the first two bases are formed with tighter consolidations and clean
breakouts. By the time the stock gets into its third base, you can see weakness
develop as a choppy handle led into a low-volume breakout.
During the later-stage
bases, the company was earning a reputation as “superstar” with superior earnings. Below is a chart of the fourth base.
When Amgen gets into its fourth base,
a breakout to new levels is made, but it is not supported with a volume boost.
This weak breakout reverses, and the stock quickly enters a downtrend that it
has yet to recover from.
Because the stock has since traded
lower than base number 4’s lows, the base counting starts all over. Because the
stock is still in a downtrend and a convincing shakeout has yet to occur, a new
base may be a ways off.
Example 2:
(
AFFX |
Quote |
Chart |
News |
PowerRating)
The following example with Affymetrix
(
AFFX |
Quote |
Chart |
News |
PowerRating) shows three bases formed within the span of a year. In typical
fashion, the first two bases formed neatly with clean breakouts, and the third
base gave signs of weakness. As with the example of Amgen above, the third base
has sloppier form with a low-volume breakout, relative to the distribution on
the left side of its base. Nonetheless, the stock had a huge run-up and created
a climax top that marked the end of its run. Also notice how the volume
increases through the year. This represents the increasing popularity of the
company.
When To Start Counting
Again
Example 3:
(
ORCL |
Quote |
Chart |
News |
PowerRating)
Just as a stock’s bullish move
eventually comes to an end, there is a corrective phase that allows for the base
counting to begin all over. Anytime the stock trades below its prior base, the
counting is reset. In this example, Oracle formed a base that had a weak
breakout which marked the end of its run. Within a year it traded below the low
of its last base, making a W-bottom that was the result of a long
corrective phase.
The next chart shows the
action which followed.
With the W-bottom on the previous
chart as “Base 1,” we can see Oracle went on to form two more bases
before finally topping out with the rest of the tech industry in the year 2000.
Once again, the third base begins to show its weakness with a deeper bowl and a
low-volume breakout to new highs. Top stocks will usually trade in tandem with
the overall market.
Final Words
Base counting is an aspect of
intermediate-term trading that should never be overlooked nor underestimated.
Knowing where a stock stands in the big picture will keep an investor aware of
potential beginnings and ends, to better time entries and exits. Ideally, we
want to be buying first- and second-stage bases, though this by no means
excludes making nice profits from later-stage bases. It pays to always be aware
of your trading environment to make the best possible decisions. With this
perspective, the IT trader will have better judgment over individual stocks, and
the overall market. Nothing comes easy in this business, but a little education
can go a long way.
Best of luck,
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