There are great-looking base patterns. Then there are some that are not so good. So how do you find the great ones? The great patterns will rarely show wild price action. So train your eye to look for those that illustrate tight, constructive price action.
In a great base, some days will show big gains in heavy trading. That’s desirable. Yet others will feature bone-dry volume as well, especially on down days in price. That’s also desirable. It signals that hedge funds, mutual funds and other institutions are seriously building positions in the stock.
“If the base pattern has a wide spread between the week’s high and low points every week, it’s been constantly in the market’s eye and frequently will not succeed when it breaks out,” IBD founder William O’Neil wrote in his classic “How To Make Money In Stocks.”
Wide-and-loose patterns are not what you want on your watch list. Price action that is all over the place suggests a real battle between buyers and sellers.
Some stocks are in fact more volatile than others. Tech and Internet stocks tend to be more volatile than food and utility issues. But generally, swings of 10% to 15% in a single week are bad.
Wide-and-loose bases also tend to be deep, so that makes it a double whammy. So any correction deeper than 35% should be treated with suspicion. Jagged and lopsided bases are also pitfalls.
Instead, focus on ones that display symmetry within the base. This suggests an element of control as a base takes shape. The base should also show tight weekly closes from week to week. It implies that shareholders are comfortable with the stock at current prices. They refuse to sell.
Apple (NASDAQ:AAPL) showed strong action in a base formed last year. In early September, shares consolidated in nice, tight fashion, with most of the action contained at its 10-week moving average (1) . The stock formed a flat base with a 103.84 buy point. It was a textbook pattern that spanned 7 weeks and corrected just 8%. Apple cleared the base in the week ended Oct. 24 and rallied for six weeks straight. Shares climbed 15% before settling into another flat base. The second pattern had fewer tight weekly closes, but it featured strong up weeks in big volume (2). Funds clearly accumulated shares.
Apple broke out again past a 119.85 buy point and rallied another 11% by late February.
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