Reading Stock Charts, Part II, continued
Not All Proper Bases Look Perfect
Perhaps you find yourself glancing at stock charts and nothing even remotely resembles a cup-with-handle or double-bottom pattern. Indeed, few times there are textbook examples of these bases. Quite often a pattern may look like a broken cup rather than a perfectly formed cup. Yet that doesn’t necessarily make a base faulty. Bases tend to trace the general market’s direction, and that results in some bases that appear a little distorted. Here are some examples that illustrate the point.
America Online
The Internet powerhouse formed a 10-week cup in 1998. But its handle in the four weeks that followed didn't appear right. The handle corrected nearly 30% (to point 1) after the cup peaked on the right side (point A). That's far more than the correction normal bull market cup-with-handle patterns should have. However, this particular handle did not scuttle the base. Why? At the same time the handle was forming, the general market was weak, and in the last sell-off at the bottom of a bear market. In fact, the Nasdaq undercut its prior low (point 2) in October 1998, when the handle was forming. Given the bear market, AOL's handle could be forgiven for having sunk more than normal. Also note that the handle's low remained above the low of the cup portion, while the market made new lows. AOL staged a breakout as it cleared its pivot point at $60 on heavy volume.
Charles Schwab Inc.
This was another cup-with-handle pattern that defied the norm. Its handle sank 26% (to point B), also a greater percentage than desirable during normal bull markets. But, again, the handle was not so out of character if you take into consideration the sharp sell-off the general market suffered in October 1998 (point C). Schwab's breakout came as it pierced its pivot point (10 cents above the peak price in the handle, noted by point A) on heavy volume as the general market indexes confirmed a new uptrend.
Cisco Systems
At first glance, this chart appears like a lopsided cup. But if you look carefully, the stock formed a double-bottom base. The second bottom dipped lower than the first, which is desirable, and the stock broke out of its pivot point (point A), which is where the price clears the midpoint peak (point B) in the base. After five days of gains, the stock retreated some. But notice it never sank 8% below the pivot. In fact, the stock reversed, closing in the upper part of its price bar for the day, which is positive action. Indeed, Cisco went on to a 1,400% gain over the next 36 months.
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