“The way to learn to do things is to do things. The way to learn a trade is to work at it. Success teaches how to succeed. Begin with the determination to succeed, and the work is half done already.” -Benjamin Franklin
 
  »

Chart Base Patterns


In my last post I demonstrated the very basics of reading a stock chart. The next step is learning how to spot chart base patterns and when to buy a stock. A chart base often acts as a foundation for stocks to “jump” off of; to begin a large share price increase. Spotting and understanding chart bases is a science that takes time and experience to learn. It is a skill that I am still working on, and I hope that writing this post will help ingrain the concepts in my own head. That being said, the best resource I have found for learning about chart patterns and all the intricacies is William J. O’Neil’s book, How to Make Money In Stocks and Investors Business Daily/Investors.com.

There are several base patterns that William O’Neil and company have studied and present to us to watch for. “Cup-With-Handle”, “Saucer”, “Double Bottom”, “Flat Base”, “Ascending Base”, and “3 Weeks Tight” are 6 principal patterns.

Cup-With-Handle

cup-with-handle

The Cup-with-Handle Base is probably the most common base pattern. It looks a bit like a tea cup when viewed from the side. Here are characteristics to look for as this pattern forms:
1. A prior uptrend of 20-30%.
2. Depth of 15-35% from peak of prior uptrend to bottom of cup.
3. Length of at least 7 weeks from start of the “cup” to the end of the “handle”.
4. Handle formed in top half of base and a pullback of 10-15%.
5. The buy point will be when, after the dip, the price reaches the same price as the handle peak plus 10 cents. You want to see this “breakout” to the new high on higher than normal volume.

Apple Chart Cup with Handle Base

Here’s an example of a Cup-with-Handle in action. Apple (APPL) broke out in March 2004 and went on to post over 1400% in gains in less than 4 years.
1. Cup with Handle Base.
2a. Handle drifts down along lows.
2b. Volume dry up in handle.
3. Buypoint – 10 cents plus peak of handle.
4a. Breakout.
4b. High Volume on breakout.

Saucer

Saucer Base

The Saucer base is basically a long, drawn out cup base. Characteristics of a Saucer are:
1. A depth of 12-20%.
2. A length of 7 weeks to more than a year.
3. If a handle forms then the buy point is the peak just before the pull back plus 10 cents.
4. However a handle will often not form after the long period of this base. If there is no handle then the buy point is the peak on the left side of the saucer plus 10 cents.

Double Bottom

Double Bottom Base
The Double Bottom Base resembles a “W”. The characteristics of  a double bottom to watch for are:
1. A depth of about 35%.
2. A length of at least 7 weeks.
3. Middle peak lower than the first, and above the midpoint of the entire base.
4. Low of second leg should be lower than first leg.
5. Buy point is 10 cents plus the middle peak.

There are also technical reasons why these patterns work. The uptrend at the begining of each base shows there is a record of price growth and that the stock has gotten support from large institutional investors which make up the majority of buying and selling that happens in the stock market. The downturns in the bases are often a result of selling by the big investors in order to take profits, or a downturn in the overall market has occured. This also shakes out smaller investors who bought at the peak. Once the major selling has subsided, the big investors begin to accumulate the stock again, and the price will begin to rise signaling strength in the stock. When the stock price approaches the price of the initial peak again, selling will start as investors who waited out the downtrend have recouped there losses and sell in order to break even or make a small gain (overhead resistence). This selling is where the handle forms and further shakes out the weaker investors. Once those investors are gone, the stock faces less resistence or selling pressure and the stock is free to break out and head higher.

The key to being succesful reading bases is to be able to spot them as they form. If you spot the base after it has already completed, then you will often miss the buy point. It’s easy to see the pattern after it has formed and the stock has run up, but spotting the pattern and following it to the proper buy point takes experience. It is best to watch for bases on a weekly chart, then use a daily chart to determine what the correct buypoint is. Once a buypoint is determined a Buy Stop Order can be placed to purchase shares at the price. Being sure to buy stocks at the correct buypoints after spotting a base provide a much greater chance at making money on a stock, but nothing is full proof and there will be times when the breakout fails and the stock procedes to fall and it won’t neccesarily recover no matter how strong the fundamentals look. That is why it is of utmost importance to always cut your losses at 7-8% from your buypoint. Cutting losses will ensure you live to see another day.

My next post I will look at 3 more Chart Base patterns…

Tags: , , | Category: Beginner Investment, Investing, Stocks

82 comments to Chart Base Patterns

1 2
1 2

Leave a Reply

 

 

 

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>