Investor's Business Daily, May 3rd, 2007
Investing is all about resisting temptation. You think you've found the perfect stock. Earnings and sales are soaring, the latest report blows away views.
But if that stock doesn't form a proper base, stay away. A faulty base makes for a faulty investment.
There are thousands of stocks in the U.S. publicly traded arena. But decades of IBD research show that there are only a handful of recognized chart patterns. They are:
Cup-with-handle
Cup-without-handle
Cup-with-high-handle
Flat base
Double-bottom
Three-weeks-tight
Four-weeks-tight
High tight flag
Ascending base
It's not enough that a stock breaks out of a base. That base has to be a recognizable pattern for the stock to have the best odds of success.
A stock's breakout is as much a part of the equation as the base from which it launches. You want to see your stock grab a big price gain on the day of its breakout.
Volume should surge to at least 50% above average levels. For smaller-cap stocks, a breakout on double normal trade, or better, is preferred. In general, the bigger the price and volume gains on the breakout day, the better.
Chipmaker Hittite Microwave HITT, a stock with strong earnings and sales growth and other bullish traits, broke out of a six-month cup-with-handle base on April 20 of this year with a buy point 15f 45.10 (point 1).
But the stock corrected 39% during its base, a bit of a steep slide (point 2).
A look at that breakout day shows a major flaw. Volume came in below average (point 3). A breakout try with no volume surge is ominous.
So what happened? Hittite eventually bounced higher April 26, with volume rising to 53% above its norm (point 4). But it reversed lower the next day in double its average trade (point 5). Hittite has found support above its 50-day moving average. But it has work to do before mounting another breakout attempt.
On the upside, CBOT Holdings BOT, parent of the Chicago Board of Trade futures exchange, lodged a classic cup-with-handle breakout last year.
The stock's correction within its base was a mild 16%. Volume in the handle bullishly dried up. Trading ranges tightened as the handle progressed. Volume on the breakout soared to more than three times its average. The stock has since vaulted 52% from its 126.59 buy point.
