Let's say you buy a stock when it breaks out of its base and clears its , but then it starts to pull back. What to do
One option, of course, is to sell all or most of the position to protect whatever profit you have.
Another would be to hang on to see if the stock can rebound or form a base-on-base pattern.
A base-on-base pattern, like the name suggests, is a base that forms on top of a base. It usually occurs during a period of market turmoil, when even strong stocks come under pressure and consolidate rather than march higher.
For a base-on-base pattern to be viable, the new base must form before the stock has risen 20% above its buy point from the initial base. It's okay for the upper structure to fall back to or below the lower pattern's buy point.
But if the upper part falls 7% to 8% below the first base's buy point, sell shares to cut losses if you bought at the first .
Base-on-base patterns can be deceptive. It's easy to view the stock as a failure because it consolidates so quickly after its breakout. But the structure often produces powerful breakouts once a new market uptrend begins.
"It's like a spring that is being held down by the pressure of a heavy object," IBD Chairman and founder William J. O'Neil wrote in "." "When the bearish phase in the overall market ends, as it always does, this stock is more apt to be one of the first to emerge at a new high en route to a huge gain," O'Neil added.
A base-on-base pattern is considered a single structure, not two separate bases, and it's the second part of the pattern that's most important. It should be a properly formed base with a well-defined buy point.
Ancestry.com , a provider of family history information, cleared a 21.45 buy point from a base-on-base on Sept. 20, 2010, in triple average daily trade.(1) At the time, its Accumulation-Distribution Rating was a best-possible A+. had accelerated for four straight quarters.
The second half of the base began forming in mid-August, when the market was in a correction. Notice how was light in the down weeks.
The stock began picking up in early September as a new market uptrend began. Ancestry.com more than doubled over the next seven months, hitting a peak of 45.79 on April 29, 2011.