V-Shaped Bases Don't Spell Victory For Growth Investors

Investor's Business Daily

Winston Churchill made "V" the most popular of letters. His famous V-for-victory gesture helped raise the morale of the British people under heavy attack during World War II.

But the V isn't such a great thing for students of stock charts.

A V-shaped base is to be avoided because it has a very high failure rate. The best cup-base patterns tend to have rounded, or U-shaped, bottoms. They look like the silhouette of a cup.

A gently rounded cup with a few weak spells near the bottom helps shake out or wear out remaining weak shareholders.

But a V-shaped base shows a stock that recovers quickly from sharp losses. This may sound good, but it doesn't allow enough time for certain shareholders to come to the conclusion their stock isn't going to recover, and thus give up on it and sell their shares.

The stock building a sound base will be under accumulation by savvy institutional investors who might spend weeks or months building a large position.

You want your stocks held by strong holders who are less likely to sell once the advance to begins. The process of base building is the jettisoning of weak holders in order to add strong holders.

Take the example of Ixia (XXIA), a computer networking company, during its trading action in 2005. To the new or beginning chart reader, Ixia may have built a sound base. It corrected 31% over 13 weeks, well within the confines of a normal correction.

But take a close look at the week ended April 22, 2005. The stock dropped 12% that week on heavy 1, finishing near the low of the week. It would have been more constructive if the stock had reversed to the upside near the bottom. Many successful stocks do that.

Then, Ixia climbed for six straight weeks, never pausing for a pullback or building a that could have shaken out any remaining weak holders. This action gave the base its V-like look.

The stock broke out past a 19.99 entry June 2. At the time, Ixia held a 90 Composite Rating, an 80 EPS and 97 RS. But Group RS was a lowly D.

Ixia had trouble holding its high from the beginning. At the time, the general market was a bit ragged, but remained in an uptrend. But by late June, the stock slumped more than 8% below the proper entry, triggering the golden rule of cutting losses short. During the week ended Oct. 21, the stock tumbled 20% 2.

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