The base-on-base is all about second chances.
It turns a stock's ugly base into a thing of beauty. Or it could give an investor who initially missed the boat a new opportunity to climb aboard.
So, what's a base-on-base? It's exactly what it sounds like: One base sitting on top of another. This is key: The price ascent between the first base's and the top of the second base should be no more than 20%.
The first base need not be pretty. In fact, in could be so flawed that you wouldn't think of buying it. Or maybe it's perfect.
Either way, it's the second base that counts. There, you're looking for the same perfection you'd seek in any candidate for your portfolio.
And if that second base is perfect or at least very good, you don't care about the stock's earlier sins. It's been absolved.
Be sure that the second-base's low point sits at least as low as the first base's peak — some overlap is ideal.
But if the second base just hangs above the first base without touching it, the entire structure is flawed. At that point, you can buy the second base's , but it's not a base-on-base.
Why is that important? Because a base-on-base counts as one base. If the first base was a first-stage structure, so is the entire base-on-base. And you should be counting bases. When the base count gets to three or four, you're looking at a . The base-on-base helps keep your stock young.
Lululemon Athletica (LULU), which struck fame and fortune by retailing its own line of yoga-themed exercise get-ups, shows a classic example of how a base-on-base can repair a deeply flawed chart.
Lululemon cratered 88% from May 2008 to March 2009 — reflecting the subprime-mortgage crisis and accompanying stock-market collapse. The stock bottomed and built a faulty, upward-slanting eight-week (1) from October to December 2009.
So what are you looking at? A cup-with-handle base that runs 88% deep. You can't take that seriously. You don't. The stock breaks out and fizzles. You feel good about your prudent decision.
But Lululemon went on to build a seven-week cup. (2) It ran just 22% deep. Lululemon broke out in late December and formed a slew of bases over the next two years, ultimately rising 390%.