Successful stock market investors always look to keep the odds in their favor. For those who want to learn how to invest in stocks, that means focusing on earlier-stage bases rather than the more obvious later-stage formations.
Counting bases is how you can tell if a stock's long-term advance is getting too old. The first couple of bases works best, and the odds of success drop with subsequent bases.
Here's the main rule of counting bases: Stocks must climb at least 20% from the previous buy point before they can be considered to be in the next stage of base formation. So, if a stock climbs only 10% to 15% from a first-stage base, the next base hasn't ascended to second-stage status. A stock can form multiple bases that are all first stage.
According to IBD research, first- and second-stage bases are most likely to lead to big gains than later-stage formations. By the time a third-stage (or later) pattern appears, most of Wall Street is already talking about the company and the stock. As IBD founder William J. O'Neil taught, "When it's obvious and exciting to everyone, it's too late."
Once a stock breaks down and goes through a deep decline, it may rejuvenate itself and "reset" its base count. Most often, that happens when the stock undercuts the lows of the prior base. An unusually long consolidation — about a year — also resets the base count.
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How To Invest: MercadoLibre's 2020 Run
During the 2020 Covid-19 outbreak, Latin American e-commerce giant MercadoLibre tumbled around 44% in just four weeks, bottoming in March 2020. Amid that plunge, shares undercut the lows of their prior cup-with-handle base (1), resetting the base count to first stage.
After a six-week rally, MercadoLibre staged a bullish breakaway gap past a 633.20 buy point in the cup with handle on May 6, 2020 (2). The stock would go on to more than double in just three months before the start of the next base.
Surely, that was more than the 20% climb required to establish the next-stage base.
MercadoLibrew traced a nine-week cup base (3). This was a second-stage base. Following an Oct. 13, 2020, breakout, shares advanced as much as 59% before topping on Jan. 21, 2021.
MercadoLibre went on to form a 31-week long cup with handle (4). This base was third stage, and the stock's advance was showing its age. In early September 2021, MercadoLibre staged a lackluster breakout attempt (5).
A few weeks later, shares triggered the 7% loss rule and broke below their 50-day moving average line — two sell signals. Over the next nine months, MercadoLibre would go on to plunge 70%.
Be sure to count proper bases only. IBD MarketSmith pattern recognition identifies the stage of every base.
Follow Scott Lehtonen on X, formerly known as Twitter, at @IBD_SLehtonen for more on growth stocks and how to invest in the stock market.
