"Trade the market you have, not the one you want," is an adage among traders, often echoed on IBD Live, but one that indeed bears repeating for stock chart reading.
When you have moved much of your portfolio to cash, it can be tempting to spring on the first halfway decent pattern that appears in your screens. After sitting on your hands for so long, you might not have even noticed your cup-with-handle base is too deep to trade reliably.
"But it's a cup with handle. We like those," you may say. At first glance, yes. But take a closer look. How deep is the base?
If you use MarketSmith, hover over the base and it will show you the stock chart's stats. If not, this can be done manually. Divide the lowest price in the base by its high, where the pattern begins. Subtract that from 1, and multiply by 100 to get the percentage.
Beware Stock Chart Bases Deeper Than 33%
In "How to Make Money in Stocks," IBD founder William O'Neil wrote that the decline in a proper base "varies from around the 12% to 15% range to upwards of 33%." If your stock has corrected more than 33%, that should give you pause. If it's 35%, 40% or higher, you have a deep base that is faulty.
While there are a few specific circumstances that can allow a deep base to succeed, these are the exceptions, not the rule. The main exception is in bear markets when many deep bases often form and can still work out.
A trader may scream, "So, it's a big cup with handle? Still a cup with handle!" The difference between a normal base and deep base isn't simply a modest difference in percentage decline. A stock that corrects 30% needs to rebound 43% to break-even. At 40%, that goal rises to 67%. At 50%, a stock needs to double in price. All of that is to just break-even — never mind breaking out and making a profit.
Shedding Some Light On Deep Stock Charts
SolarEdge Technologies is the Israel-based maker of inverter systems for solar power harvesting and photovoltaic monitoring technologies. From its pandemic low, the stock ran up over 450% to its peak in January 2021.
This monumental run was followed by significant selling. Back-to-back deep bases formed. A 45-week cup with handle with a depth of 47% and 371.18 buy point (1) and a 17-week base with a 48% depth and 335.67 entry (2).
Likely struggling with the overhead supply, neither base could successfully break out. Each time SEDG clawed its way back near highs, traders who missed their opportunity in the base prior were looking to sell as soon as they could break even or with reduced losses.
In both bases, the price of SolarEdge would fluctuate more than 10% in a single week. Volatility like that indicates fear in the market and that the breakout is likely to fail.
