Reading Stock Charts, Part I, continued
Chart Patterns To Look For
The results of our study of greatest stocks showed these stocks advanced after being in basing patterns, or chart formations, in which stock prices move basically sideways, or "consolidate," over a number of weeks. Often, these can precede potent upswings in price, so recognizing the characteristics of a good base is vital. When we say sideways, we're not referring to stocks in the doldrums. Rather, these are situations in which a stock has moved up in price—preferably at least 30%—but begins to level off or correct in price.
Proper bases serve an important purpose: to adjust for the previous price uptrend and to get rid of weak holders. Those who would be most likely to sell will generally do their selling in the base-forming period. This gives the stock the chance to really move when the base is completed. The new buyers and those buying additional shares can then move the stock up without the selling pressure that weak holders would otherwise pose.
Sometimes, however, selling pressure can be too much for a stock to overcome, so you must learn to tell the difference between a faulty base pattern and a sound one. What does a correct base look like? There are a number of different types of patterns that you look for that will make it easier for you to recognize when you are looking at a base with potential.
Most successful stocks build a number of bases as they pause on their way to larger gains. The first time a stock forms a solid base, few people are even aware of the company, so most miss this first-stage base. More people notice the company during it's second base after the stock moves up 20 to 30% from the first stage base breakout point. By the time third- or fourth-stage bases have formed, many more investors have belatedly "discovered" the stock. This, however, is when the stock is more likely to disappoint you. In about 80% of fourth-stage bases, the stock fails to make further price increases. Frequently, the stock sputters as the general market turns lower. If the stock then declines below the low point in either the third or the fourth-stage base and later recovers to build sound base, you can usually start counting bases all over again. The sharp price shakeout has eliminated the stock from weaker owners. An Investors Corner Article explains this concept in greater detail.
You'll see most of these basing formations in quality stocks during times of weak general markets. Once the general market has a confirmed turn up, quality stocks spring out of these basing formations with renewed energy. This is the best time to get into a stock.
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