Counting Bases
IBD Meetup 10.28.9
“Sell when your stock makes a new high in price off a third or fourth-stage base. The third time is seldom a charmin the market. By thenm an advancing stock has becom too obvilous, and almost everyone sees it. These late stage base patterns are often faulty, appearing wider and looser. As much as 80% of fourth-stage bases should fail, but you have to be right in determining that this is a fourth stage base.”
How to Make Money in Stocks Fourth Edition p.268 Sell rule #3
So what is a base?
How are they counted?
Investors.com has a glossary of terms. Use the search feature and type in the term. Click “search site” and enter.
Stage of a Base: term referring to the number or 'stage' of the bases a stock will form as it advances on its way up in price. Successful stock advances over a year can consist of two, three or four bases on the way up before going into a major decline. The initial base is referred to as a 'first stage' base, the second base as the 'second stage,' etc.
Rule #1: Bear markets reset all base counts back to zero.
March 12 marked the birth of the current bull market according to IBD’s Big Picture column which follows the major indexes day to day. Several stocks such as LFT, NFLX, TNDM broke out at this point. Many others broke out in the next six weeks (GMCR, SYNA, PNRA, BWLD). These were all first stage bases even though some of them had positive chart activity during the bear market.
Rule #2: A stocks price must advance at least 20% from the prior base before forming the next valid base.
After a breakout the stock could break down 7-8% below the buy point violating a sell rule. It could also advance higher and form a second stage base. If the stock fails to advance 20% prior to forming its next base it is considered a base on base and is still part of the first stage base. This could happen several times creating an ascending base but it is all still part of the first stage base.
Second stage bases can be just as powerful as the first stage base so it’s important to follow quality stocks after their initial break outs. They may set up in a second stage base and give you a second chance to buy them. Note that you don’t want to buy ahead of a proper buy point since you have no idea what the stock may do or whether or not a second base even forms.
From “How to Make Money in Stocks 4th Edition, look at EMC (p.81) and Dell (p.89) for examples of stocks that gave a second chance to patient investors. Note that these charts are completely new to the 4th Edition. There is a wealth of information available in carefully studying these charts. Traders who work for O’Neil have studied these charts in close detail and use them to inform their trading decisions. You should too.
Yahoo (p.90) shows a false base at the second stage before forming a proper second stage base. Note that there was never a proper set up so there was never an entry point. This represents the “art” of chart reading and the reason it takes experience and study.
Qualcom (p.94) shows an ascending base after what appears to be the break out point of the second stage base. However this is simply a pullback since a proper base didn’t form. This ascending base is the second stage base.
Rule #3: If the price drops below the low of the previous valid base, it resets the base count.
Apple (p.99) is a great example of the use of base counts. Note the fourth stage base breaking down and resetting the base count. Note also that the false second stage base breaks down and would have been very painful for those not following the rules.
Rule #4: 80% of all fourth stage bases will fail.
Third and fourth stage bases are more likely to fail. One reason is that everyone will have seen them and the market moves to destroy the obvious. Another is simply that stocks only have so far they can run before they collapse of their own weight. Cisco (p.79) is the notable exception that proves the rule. Attached are two charts showing the different bases in the stock’s legendary run. CSCO continued to add bases, reset and take off to new highs throughout the Nineties. At its peak CSCO was the largest company in the world by market cap: a poster child for the NASDAQ bubble. How can the world’s largest stock double yet again? Eventually, it crashed back to earth. Nimble investors got off the elevator on the way up.
So where are we now?
Most stocks that broke out of bases in the initial weeks of the new bull market in March are now extended well beyond proper buy points. Several stocks pulled back during the correction in June. Some of these such as NFLX, PCLN and GMCR have now broken out of new bases. Few if any stocks are in danger of being in a late stage base. This concept becomes more important during the later stages of a bull market. What is important is identifying the base count of any stock you chose to buy. You’ll know to be cautious of holding a stock through a correction if you bought it in a second or third stage base and not to buy stocks breaking out of late stage bases.
Happy Hunting,
Richard McKay
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