When it comes to investing in growth stocks, our goal is to maximize profit while minimizing risk. Learning to read charts is key in how to buy stocks. Having learned about the various base patterns — cup-with-handle, double-bottom, etc. — the next step is learning how to count bases.
As simple as it sounds, this is crucial in gauging a stock's vitality.
Every leading growth stock will form a series of bases over its long-term advance.
First- and second-stage bases tend to produce larger gains than a third- or fourth-stage bases. Simply put, a growth story tends to draw the most investors early in its run. After a while, the growth fades, as does enthusiasm about the stock.
First-stage bases can form after an IPO, a market correction, or after a major decline in a stock of a year or longer.
The next base to form is not necessarily a second-stage base. Check how much your stock has climbed from the buy point of the previous base. If there is at least a 20% gain between the buy point and the left-side high of the new base, count that as a new, separate base.
If your stock does not have a 20% gain between two bases, count those as a single stage in your base count. If these bases don't overlap too much, a combination of two bases near each other could even be considered a base-on-base pattern.
In the event that a stock goes through a decline so severe that it undercuts the most recent base, you will reset the base count. The next base to form will start over as stage one. Many times, these big declines, or resets, happen in bear markets.
The 1,2,3 Of ABC
Google parent company Alphabet completed a first-stage base in May 2020, following the lows of the Covid bear market. This deep cup pattern eventually hit 22% profit in early September before reversing that same week.
The second-stage base formed in September and October of 2020. (Not shown in the illustration.) With a gain of just 9.6% from the buy point, GOOGL pulled back in a flat base.
Twice more, it found support at the 10-week and tried again to breakout, making gains of 16%, and 13%. In all, four bases failed to make 20% gains, making the entire run a second-stage construction. (1)
A third-stage base formed in September and October 2021 (2) would not be so lucky. Alphabet's run was showing its age by then. IBD research shows that third-stage bases have a success rate of 67% and that drops to 20% for fourth-stage bases. Looking at GOOGL, it's easy to see why.
From the buy point of the original second-stage base to the start of third, GOOGL had risen 70%. It had run out of steam. The third-stage pattern collapsed into a loose consolidation (3) that undercut the 40-week moving average. Alphabet stock continued lower for months.
