Sometimes, you can't just look at a stock in a vacuum. You also have to look at what's happening to the market and other stocks.
After a big correction or a bear market, investors shouldn't expect to find a lot of good-looking bases. Severe market downturns can make for chart patterns that prudent investors usually wouldn't touch.
While most of these bases will be damaged goods, a few can still be the launching pad to big gains.
The biggest thing to remember is that growth stocks are generally more volatile than the general market. They can correct 1-1/2 to 2-1/2 times the market. So if the S&P 500 slides 14%, a leading stock could tumble 21% to 35% from its high.
In bear markets, it's not uncommon to see even deeper bases take shape. After a big rally, some stocks can plunge 50% or more from their peaks. Big price spreads and wide-and-loose action will also be common. And you're likely to see deep handles and huge spikes in in down weeks.
But these attributes aren't necessarily flaws, and a stock can show strength and tight action as the base develops.
Being a successful investor involves being flexible. You have to adjust to different market circumstances. So if you're still waiting for that picture-perfect cup-with-handle base with tight action, good luck. Being on the sidelines in a fresh market uptrend might cause you to miss out on some strong movers.
Not all of your trades are going to work out, but that's where your sell rules come in. There is, however, such a thing as too steep of a correction.
While bases 50% or even 60% deep can work sometimes (see Apple (AAPL) in 2008-09), corrections of greater magnitude are excessive and should be avoided.
During the great bear market of 2008, stocks across the board suffered heavy damage. Green Mountain Coffee Roasters (GMCR) was nearly cut in half over a four-month period from June to October 2008.
Green Mountain had some wide-range down weeks on the left side of its base, (1) but the right side clearly showed tighter action. (2) The stock cleared a 42.99 (before two splits) in the week ended March 20, 2009.
The stock vaulted 122% before retreating to its 10-week line. (3) It went on to become one of IBD's top stocks for 2009.
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