A key component of intermediate-term trading is the base. From the base come all good trades in this strategy. This lesson explores base counting as a method to gauge where a stock might be in its life. Typically, a strong stock will form several bases before topping out. The stocks will also trade in similar fashion to the overall market. From what Mark Boucher and his indicators have been telling us lately, we may very well be at the beginning of a new bull run. Taking a look at the bases of individual stocks will keep us ready to act when the time is right.

An ideal base for the intermediate-term trader will be at least seven weeks long. For the base to properly trigger a pivot buy point, the price action must trade on high volume 10 cents above its most recent consolidation. This is most often in the formation of the famed cup-with-handle pattern. If the breakout is good, and the stock is able to move at least 25% above its pivot buy point without first trading lower than the base, a new base can form. Counting bases is most easily done when analyzing weekly charts.

How The Bases Stack Up

A strong stock in its first base is usually at a point where the company is quietly doing its thing, and little attention is paid. As the company continues to produce superior earnings, its popularity increases and successive bases are formed. When the masses finally catch on, the stock is often into its third base or higher, and weakness is evident in the formation.

When a stock finally tops out, it will typically occur at a time when the company is being profiled on the covers of popular magazines, and being touted as a "must own." As the masses pile on, the price runs up, and ultimately the buying pressure exhausts itself, making way for the sellers. Not all stocks are strong enough to make it into late-stage bases, and it is very rare for a stock to move past fifth and sixth bases. Sell-offs in top stocks will often occur when the market is declining as well. The examples used for this lesson all contain intermediate-term selections that faltered in their later-stage bases. The final example shows a situation in Oracle (ORCL | Quote | Chart | News | PowerRating) where the base counting is reset after the stock trades below its base.

Example 1: (AMGN | Quote | Chart | News | PowerRating)

This chart shows Amgen (AMGN | Quote | Chart | News | PowerRating) in its run from 1998 into 2000 as it formed four bases. Notice how the first two bases are formed with tighter consolidations and clean breakouts. By the time the stock gets into its third base, you can see weakness develop as a choppy handle led into a low-volume breakout.

During the later-stage bases, the company was earning a reputation as "superstar" with superior earnings. Below is a chart of the fourth base.

When Amgen gets into its fourth base, a breakout to new levels is made, but it is not supported with a volume boost. This weak breakout reverses, and the stock quickly enters a downtrend that it has yet to recover from.

Because the stock has since traded lower than base number 4's lows, the base counting starts all over. Because the stock is still in a downtrend and a convincing shakeout has yet to occur, a new base may be a ways off.

Example 2: (AFFX | Quote | Chart | News | PowerRating)

The following example with Affymetrix (AFFX | Quote | Chart | News | PowerRating) shows three bases formed within the span of a year. In typical fashion, the first two bases formed neatly with clean breakouts, and the third base gave signs of weakness. As with the example of Amgen above, the third base has sloppier form with a low-volume breakout, relative to the distribution on the left side of its base. Nonetheless, the stock had a huge run-up and created a climax top that marked the end of its run. Also notice how the volume increases through the year. This represents the increasing popularity of the company.

When To Start Counting Again

Example 3: (ORCL | Quote | Chart | News | PowerRating)

Just as a stock's bullish move eventually comes to an end, there is a corrective phase that allows for the base counting to begin all over. Anytime the stock trades below its prior base, the counting is reset. In this example, Oracle formed a base that had a weak breakout which marked the end of its run. Within a year it traded below the low of its last base, making a W-bottom that was the result of a long corrective phase.

The next chart shows the action which followed.

With the W-bottom on the previous chart as "Base 1," we can see Oracle went on to form two more bases before finally topping out with the rest of the tech industry in the year 2000. Once again, the third base begins to show its weakness with a deeper bowl and a low-volume breakout to new highs. Top stocks will usually trade in tandem with the overall market.

Final Words

Base counting is an aspect of intermediate-term trading that should never be overlooked nor underestimated. Knowing where a stock stands in the big picture will keep an investor aware of potential beginnings and ends, to better time entries and exits. Ideally, we want to be buying first- and second-stage bases, though this by no means excludes making nice profits from later-stage bases. It pays to always be aware of your trading environment to make the best possible decisions. With this perspective, the IT trader will have better judgment over individual stocks, and the overall market. Nothing comes easy in this business, but a little education can go a long way.

Best of luck,

Daniel

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