Canadian Stocks: Current Trends and Chart Analysis

[BoomTime]

Useful Article # 5: Why Do Bases Work?

http://www.investors.com/editorial/editorialcontent.asp?secid=1107&status=article&id=1322670....

BY JONAH KERI

Why Do Bases Work? Hope, Fear And Greed

INVESTOR'S BUSINESS DAILY

Posted 7/24/2002

Fear of the unknown can be your biggest foe as an investor. Especially when it comes to stock charts and bases.

You may dismiss charts as quickly as you do palm reading. All those lines and shapes - who needs them? And what's a base, anyway? Too esoteric, too random, too voodoo for you.

It's time to conquer your fear. Why? Because bases work. Always have, always will.

Stocks form bases in step with the flow of the market. Even the best stocks can't go up forever. When the market tumbles, leading stocks carve bases.

Bases play heavily on investor psychology. A base starts when a stock begins to correct off its high. At that point, sellers are taking advantage of investor greed. A stock may be far extended from its prior base, but ravenous buyers are still willing to nab shares.

As a good base completes its left side, it often finds support at a key level like the 50- or 200-day moving average. That's where money managers swoop in and buy. They're taking advantage of investor fear as panicky traders sell.

Whether forming a cup-with-handle, double-bottom or other pattern, a properly behaving stock will then start to climb. Investors rekindle their optimism as a stock forms the base's right side.

In its final phase, a base will include a shakeout to knock the last weak holders out. Often expressed as a handle shape, the stock will drift downward, thanks to impatient investors sick of waiting for the big move.

Once those antsy folks have left, a stock is free to break out of its base, surging on huge volume as institutions jump in and buy.

Of course, it's one thing to say all these things will happen. It's another to let the greatest stock runs in history do the talking.

You'll find thousands of stocks that have formed sound bases before launching their big moves. No matter how far back you go, the same principles apply.

Let's go back almost 40 years to the start of Xerox's huge run. The copy machine maker ran up to a high of 164.50 in January 1963. After a strong prior move, it needed time to digest its gains. Xerox corrected for 2 1/2 weeks as investors took profits (point 1 in the accompanying image).

The stock found a bottom, then moved higher as buyers stepped in (point 2). On March 14 of that year, Xerox came within 0.37 of matching its high, then settled into a downward-sloping handle.

On April 3, the stock zoomed out of its base on a massive surge in volume (point 3). Xerox went on to triple in the next three years.