When it comes to investing in growth stocks, our goal is to maximize returns while minimizing risk. Learning to read charts is key to buying stocks. After learning about the different base patterns—cup with handle, double bottom, etc.—the next step is to learn how to count bases.
X
As simple as it sounds, this is crucial to gauge a stock’s vitality.
Any leading growth stock will form a series of bases over the course of its long-term ascent.
First and second level bases tend to produce larger gains than third or fourth level bases. Simply put, a growth story tends to attract the most investors early in its run. After a while, growth wanes, as does enthusiasm for the stock.
First-tier bases can form after an IPO, a market correction, or after a stock’s sharp decline of a year or more.
The next base to form is not necessarily a second stage base. Check how much your stock has risen from the previous basis buy point. If there is at least a 20% gain between the buy point and the left high of the new base, count this as a new, separate base.
If your stock doesn’t show a 20% gain between two bases, count it as a single phase in your base count. If these bases don’t overlap too much, a combination of two closely spaced bases could even be considered a base-on-base pattern.
In the event that a stock falls so sharply that it undercuts the last base, reset the base count. The next base to be formed starts with phase one. Often these large pullbacks or resets happen in bear markets.
The 1,2,3 of ABC
Google parent company alphabet (GOOGL) completed a first base phase in May 2020 following the Covid bear market lows. This deep cup pattern eventually peaked at a 22% gain in early September before reversing that same week.
The second stage base was formed in September and October 2020. (Not shown in the chart.) Gaining only 9.6% from the buy point, GOOGL retreated to a flat base.
It found support at the 10-week mark twice more and attempted to break out again, posting gains of 16% and 13%. Overall, four bases failed to make 20% gains, making the entire run a phase two construction. (1)
A third stage base was formed in September and October 2021 (2) wouldn’t be so lucky. Alphabet’s run was aging by this point. IED research shows that third-level bases have a 67% success rate, dropping to 20% for fourth-level bases. If you look at GOOGL, it’s easy to see why.
From the purchase point of the original second stage base to the beginning of the third stage, GOOGL was up 70%. It had run out of breath. The third level pattern collapsed into a loose consolidation (3) which undercut the 40-week moving average. Alphabet stock has been in the red for months.
YOU MAY ALSO LIKE:
Get FREE IBD Newsletters: Market Preparation | Technical Report | How to invest
What is CAN SLIM? If you want to find successful stocks, you should know better
IBD Live: Learn and analyze growth stocks with the pros
MarketSmith’s tools can help the individual investor
