It’s a good idea to track the number of bases a stock has formed during its current run-up. As a rule of thumb, try to buy stocks that are breaking out of the first or second base of their run. Late-stage bases are riskier. Late-stage means a base that’s number three or higher in the base count.
Why is it Important to Spot a Late-Stage Base?
After forming a fourth base, most growth stocks can’t rally much further, if at all. What usually follows is a long, steep slide. After a stock has had a large advance without a major correction, the probabilities are greater that institutional investors will cash in their profits and push the price into a serious decline.
By the time a stock forms a late-stage base it’s usually widely known to investors and running short on fresh buyers. In addition, the late-stage base tends to have unsteady price swings, bouts of strong selling or other flaws. It’s the chart’s way of telling you that the best buying opportunities are gone.
Late-stage patterns can work and sometimes do lead to nice gains, but you should understand that they involve more risk. If you buy a stock on a late-stage breakout, be sure to cut your losses quickly if the stock fails to gain traction and begins to head south.
Counting bases is not difficult, and with a little practice, you’ll get the hang of it.
To count how many bases a stock has formed, take a look at its weekly chart:
Generally do not count bases for stocks until company quarterly earnings and sales start growing by at least 25%.Each base should form at least 20% above the buy point of the base that preceded it.
If a stock advances less than 20%, then forms another base, it’s all counted as one consolidation called a base-on-base. The buy point is figured from the current, most recent pattern.
Bear markets reset the base count back to one for all stocks, clearing the path for a new bull market, with fresh leadership. So start the count with the first break out from a base after a bear market has ended.
A stock will also reset its base count if its price drops so deep that it undercuts the lowest point in the base that preceded it.
Granules India, a global pharma player, broke out of a first-stage base in October 2013, and advanced 77% in four months. It then made a second-stage consolidation base pattern in February 2014, and had a great run after it broke out of that base in April 2014.
While following the chart, one could have easily spotted the phenomenal return the stock had given in just one year after breaking out from first-stage base. The return was a whopping 461%. However, after superb rally the stock consolidated and formed a third-stage base-on-base pattern. Having paused for almost a year, the stock broke out in July 2015, and gained 56% in three months.
By now, Granules India’s stock had multiplied 11 times in just two years. It then formed a short duration fourth-stage base, which eventually failed. The lack of fresh buyers led to a time correction. It corrected by as much as 38%, breaching the previous base low in the process, and thereby resetting its base count to one.
The odds of winning a substantial profit shrink considerably in a late-stage base. That’s why investors need to avoid them. The stock has been languishing sideways for the last three years and currently it is trading 35% below from its all time high of Rs 164.35.
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