The S&P 500 might’ve been up 19.4% in 2017, but it was still a challenging year for many investors. Periods of market uncertainty often result in uneven performance.
But for those who outperformed, focusing on institutional-quality growth stocks with top fundamentals breaking out from well-formed bases once again was the ticket to success.
After a strong run-up, a stock will pause and consolidate gains. This is the basing process, where a true market leader catches its breath in preparation for another big move up. Recognize these five signs of a healthy base. The healthier it is, the better chance it has of delivering an explosive breakout.
One: Look for calm action as the stock starts to pull back. A quiet, orderly decline is preferable to herky-jerky, wide-and-loose price action.
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A cup-shaped base generally shouldn’t show a correction of more than 30%-33% from high to low. A flat base shouldn’t correct more than 15%; many show tight, sideways action in a much lighter pullback than that. The bottom line: You’ll see calm pullbacks and volatile ones, so focus on the former.
Two: Using a weekly chart, spot tight weekly closes at the bottom of the base. Such price stability tells you that the pullback may be ending, paving the way for a new round of buying demand. As the stock starts working its way higher toward a prior high, look for signs of heavy accumulation, or institutional buying. Big investors have a hard time covering their tracks because big volume always gives them away.
Three: When assessing the quality of a base, especially a cup with handle, look at both the daily chart and weekly chart and view the entire base. Do up weeks in heavy volume outnumber down weeks in heavy volume? If so, the stock is generally showing signs of net accumulation. You want the big funds buying shares heavily ahead of a powerful breakout.
Four: A healthy relative strength line is another attribute of a sound base. Make sure it’s at or near a new high as the stock gets into position for a breakout try. A bullish RS line, shown in blue on all IBD charts and in MarketSmith, shows you the stock has been outperforming the S&P 500 and could have the potential to be a big market leader.
Five: Look for heavy volume at the breakout. IBD’s volume percentage change, noted in all charts and quotes on Investors.com, will alert you to when volume is heavy in a stock. When the volume percentage change is 50%, it means that volume is on pace to be 50% above average. Keep in mind that volume can be heavy early in a stock and then fade by the close.
Arista Networks (ANET) gapped up powerfully last year out of a flat base with a conventional entry at 163.07. The open price of 167.60 on Aug. 4, 2017, was a legitimate buy point as well. The base showed an orderly pullback of 13% with some tight weekly closes. Shares surged 14% during the week ended Aug. 4; the computer networking gear leader has delivered an explosive gain, up 91% in eight months.
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