Mention the word “flat” in a conversation about stocks, and images of dull, laggard performance come to mind. But that’s not necessarily the case with stock charts.
A flat base is one of the few reliable patterns that quality stocks form before making substantial price advances. While it may seem like a stock is going nowhere for weeks, it may be quietly winding itself up for a big climb.
Look for these characteristics to spot a proper flat base from ordinary, meaningless sideways action in a chart:
– After a prior advance, the stock declines a modest amount — no more than 15% from its prior high.
– The shallow consolidation takes place over five weeks or a bit longer.
– Often a flat base develops after a stock breaks out of a cup-with-handle or other sound base, and climbs 20% or more from the buy point. Thus, flat bases usually aren’t first-stage bases. They will usually be second- or third-stage bases.
To find the correct buy point, look for the highest price at the start of the correction also called the left-side high or pivot of the base.
As with any other breakout, volume should be at least 40% above the stock’s 50-day average when shares climb above the buy point. The price as well as the volume should make a decisive move to new highs.
When a stock is going through this type of movement, it is quite likely that institutional investors are buying shares — adding to their positions carefully, lest they run up the price too quickly.
A month ago, India’s leading luggage manufacturer, VIP Industries broke out to new highs. The stock had traded sideways for a period of five weeks, from mid-June through late July (1). That was a third-stage flat base, with the stock declining 13% from peak to bottom.
Price action near the low of the base was mostly calm (2). When you see a chart with tight price movements, it is an indication that institutional investors are accumulating shares.
The ideal buy point was Rs 460.35. VIP Industries cleared that level on July 24 (3). It jumped 9.5% on almost 3x the 50-day average volume and closed 1.7% above its pivot price. Prudent investors would have been convinced by the breakout.
VIP’s fundamentals were sound (4). EPS growth had accelerated and increased 31%, 54%, and 85% in the three quarters before the breakout. Sales growth had also accelerated and reached 18% in Q4 FY 2018. The stock went on to gain more than 20% in less than three weeks from the breakout, thereby hitting a power from pivot flag. Stellar financial results in Q1 FY 2019 and heavy institutional accumulation propelled the stock to a high of Rs 647 on August 28, resulting in an impressive gain of 40% from the pivot price.
Related: The Strength of a Flat Base (Learning Article)
Importance of Chart Patterns (Webinar)
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