If a stock has to rise 20% or more just to get to its pivot point, that’s a possible warning sign that the handle is too loose. Such breakouts are definitely more prone to failure. In relation to a base, a good handle should appear tight and narrow on the chart. From its high to low, the handle shouldn’t decline more than 10% to 15%, especially if the decline in the overall base is between, say, 20% and 40%. For instance, when Blockbuster broke out on April 24, it left a base that corrected 39% from high to low. In the handle, the decline was just 8%. In a severe bear market, however, some great stocks do form a handle whose decline is 20% or more, and they go on to new highs.
Not necessarily. In some cases, when a base is predominantly horizontal in shape, the moving average lines can be more or less flat. But rather than looking at the slope of the moving average lines, you should check if the stock is above its 50-day moving average. If it isn’t, chances are there is something wrong with the breakout. Also, you’ll sometimes see the 50-day moving average cross above the 200-day line at about the same time of the breakout, although this crossover is not by itself a signal to buy. Overall, the overriding factor in studying any breakout is the health of the base pattern. Moving averages are just a secondary indicator.
An area on a chart that turns back a stock’s advance is called resistance. Therefore, a pivot point is a type of resistance level. A stock corrects, forms a bottom and then builds the right side of its base. As it nears the old peak, a stock often hits resistance and moves sideways or lower for a few days or weeks. This action forms the handle. A stock breaks out when it shoots above the high of the handle, which is called the pivot point.
You want to buy a strong stock as soon as it breaks out of a sound base. The closer you get to the pivot or buy point, the less likely you’ll be shaken out by a momentary pullback. Most winning stocks rarely drop more than 8% below a proper buy point. Avoid buying stocks extended more than 5% from their pivot. Should you spot a stock too late, keep an eye on it. Many leading stocks will fall back near their buy points, offering investors a second chance to climb aboard.
The reason we emphasize fundamentals is that we know from our historical market studies that the biggest winning stocks have certain, strong fundamental characteristics with respect to earnings growth, sales and profitability when they begin their big moves to the upside. When a stock tops, however, often times the fundamentals are still quite strong. Investors who overemphasize the fundamentals and ignore the technical action of the stock as it tops will likely run into trouble because stocks indeed discount the future. So, when a stock is just beginning a run, we know what the fundamental and technical characteristics must be according to our model studies, and so we emphasize both. At the top, however, we begin to look for technical clues that a stock is topping based on the fact that most stocks top while the current fundamentals still look good.