One of the most important parts of growth-stock investing is recognizing the handful of base patterns that demonstrate bullish form. But just because a chart fits the definition of a base it doesn't necessarily mean your chart analysis is done.
Even when a stock shapes a pattern with the dimensions of a flat base, cup base, double bottom or other proper base, it's just as important to spot the flaws in the chart.
Excessive declines, wide and loose price action, lack of upside volume and too much activity below support levels are the main problems that can crop up in chart analysis. Here's how you can find those flaws.
Look For Deep Bases Or Handles In Chart Analysis
Most bases should have a price decline of no more than 30% or 33%. In other words, they should lose no more than one-third of their value. Handles should drop no more than 12%.
Deep bases require a larger recovery, and by the time a stock hits its buy point, it may be ready to pull back again. Some stocks decline 50% or more during bear markets, and still come out OK.
Wide And Loose Action
A solid base should have smooth, calm price movements, reflecting an abundance of institutional investors buying and holding shares with confidence.
When a stock fluctuates, say 10% or 15%, in a single week that's a sign the market is unsure about the stock. Volatility is often a reflection of fear and uncertainty. Deep bases are often wide and loose, too.
Poor Volume In The Base
When studying a base on the weekly chart, count the number of weeks with above-average volume. A good base should have more up weeks in high volume than down weeks. This is a crude but effective way to measure institutional demand for the stock as it consolidates.
During the declining phase of the pattern, watch for down weeks that close near the week's highs. Such reversals are considered bullish, especially when the close is in the upper 40% of the week's price range.
Base Forms Below 10-Week Line, Or V-Shape
A base with strong demand should form mainly if not entirely above its 10-week moving average. In chart analysis, you should also look for the stock to bounce from pullbacks to the line, or to move above it with strong price and volume action.
Cup bases should have round U-shaped profiles, another indication of strength. Avoid sharp V-shaped cups.
Roku's Multiple Flaws
Roku went on a superb run from a breakout in July 2020 as the pandemic caused at-home entertainment to boom. The stock rallied 260% to a February 2021 peak.
At that point, it started forming a base that sank 44% — way more than normal (1). The stock formed a handle with a 14% drop, which also was deeper than normal (2). The weeks of Feb. 26, March 5, May 7 and others saw the stock swing more than 20% from high to low. That's wide and loose action.
Most of the base formed below the 10-week average, and several times met resistance at the line (3). High-volume weeks were mainly on the downside (4).
Roku's cup with handle base also looked like a double bottom. A 397.69 entry gave investors a better gain. Either way, the stock soon failed after its handle breakout.
