Author: DAVID SAITO-CHUNG
Source
In the cup with handle or double bottom, the success of a breakout depends on the way top growth stocks rise and fall within the base.
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A third key chart pattern shows that a stock can choose to take neither path before its big move north in price.
Rather than go on an uptrend or downtrend, the stock moves sideways for weeks or months. This action — or lack of it — becomes what’s called the flat base. This pattern often forms after a stock breaks out of a cup or other base, gains ground for a few weeks, then stalls. Why? The market might not be ready to rally strongly, or is still weak.
When To Buy Top Growth Stocks: Why The Flat Base Wins
But a flat base actually reflects unusual strength.
Instead of bending lower, it holds steady in price. This action tells you the stock wants to run higher.
When the market finally begins to rally, the stock explodes out of its crouch position.
A flat base must be at least five weeks in length. It can last much longer than that. Within the base, the percentage decline from the stock’s high to low usually ranges within 10% to 15%. In other words, let’s say you find a decline of 16% or more. That base would not qualify as a flat base, but instead it may fit the mold of a cup with handle or even a cup without a handle.
When the stock drops within the base, institutional investors step in to shore up the stock. The stock doesn’t fall much more because investors overall feel comfortable with the stock’s current price.
When should you buy? Wait until the stock rises 10 cents above the highest price in the flat base. Sometimes the price high is found on the left end of the base. In other cases, the high is in the middle of the base or on the right. Just add 10 cents to that price to find the pivot. Buy it as close as possible to that price point. Don’t chase it if it’s already more than 5% above the pivot.
Oracle (ORCL), the database and e-commerce software giant, muscled out of a seven-month cup with handle on Sept. 3, 1999 (1). In five sessions, the stock rose 18% and hit new highs. A fine start.
But the market suffered choppy action. From Sept. 13 the Nasdaq tumbled 7% over the next two weeks, yet held up above its 50-day moving average. Two weeks later, it strode to a new high. But the next two weeks saw the Nasdaq fall 10%, and briefly below the 50-day line.
Oracle dug in its heels.
Growth stocks tend to fall 1-1/2 to 2-1/2 times the correction in the major indexes. Not Oracle. The stock held up above 40 during most of its seven-week flat base. On an intraday basis, it fell no more than 15% below its high.
The Right Entry In A Flat Base
The new flat base’s left side showed an intraday high of 46.94. Add a dime to get the buy point.
Oracle briefly poked above the flat base’s 47.04 buy point in the week ended Oct. 15, 1999, but stumbled. A week later, Oracle dropped more than 8% below the prime entry, ushering in the golden rule of investing. Some breakouts turn out to be fakeouts.
However, one day after the Nasdaq staged a follow-through day on Oct. 28, Oracle broke out for real. It rallied on heavy volume for seven straight sessions. A follow-though is a critical signal that the market has possibly bottomed and is ready for a significant turn higher.
At the time, Oracle scored a 95 Earnings Per Share Rating, as seen in IBD Stock Checkup, and an A for SMR (Sales + Margins + Return on equity). The stock’s relative strength line, painted in blue in every IBD daily and weekly chart, shoved into new high ground. The enterprise software group was ranked third among 197 groups.
Oracle gained 273% through its March 2000 peak.
A version of this column was first published in the March 26, 2002, edition of IBD. Please follow Chung on Twitter at @SaitoChung and @IBD_DChung for more on growth stocks, chart analysis, breakouts and financial markets.
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