Thursday, September 23, 2010

Counting Bases Helps Assess Buying Risk

How are your base-counting chops?
Do you recognize when a stock resets its base count? Do you know how many bases a winning stock racks up before it tends to run out of steam? If not, here's a review.
Leading stocks normally form and break out of more than one base in the course of an advance. Keeping track of these bases is important because it helps gauge how much fuel a stock still has in its tank.
Initial bases can form after an IPO, after a market correction or after some sort of turnaround in the company's fortunes.
It's important to remember that bases formed below $10, or those which occur before a company's earnings show appreciable gains, don't count as initial bases.
There are a number of different types of bases. But all have a few common needs. One is for an advance of at least 30% prior to the start of a base pattern. Second-stage or later bases require a 20% advance leading to the left side of the structure.
Advances before first-stage bases can start from the bottom of the prior correction. For second- and later-stage bases, measure the uptrend from the prior base's buy point.
Leaders often generate follow-up or add-on buy opportunities as they move between bases. These might include three-weeks-tight patterns or pullbacks to their 10-week moving averages. These don't affect your measure of a base-to-base advance.
Sometimes stocks don't log a 20% climb between bases. In this case, the paired consolidations are considered a base-on-base pattern. These count as a single stage in your base count.
If and when a stock reaches a third-stage base, it is typically starting to run out of steam. IBD research shows the success rate for breakouts from third-stage bases is around 67%. The failure rate climbs to 80% for fourth-stage bases.
Stocks sometimes plateau after their third- or fourth-stage base levels. They can also turn down and slide into steep, long-term declines.
On rare occasions, a stock will correct back to below the level of the prior base's low point, then turn and recover. When these undercuts occur, the correction resets the stock's base count. That signals the stock may be primed for another raft of gains. The next time the stock shapes a viable base and buy point, it reverts back to stage one. Be sure that the company still has excellent fundamentals. (PCLN) has provided base counters with several valuable lessons in its recent run.

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