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Double-Bottom Base May Be Taking Shape If You See A 'W'

Let's say you've been keeping your eye on a stock that boasts solid fundamentals and is carving a cup-shaped base.

But just when it looks like the right side is nearing completion, the stock starts heading south. Should you cross it off your watch list

Not so fast. The stock could be setting up for a double-bottom formation. It tends to occur less frequently than the cup base, but can a solid and outstanding gains too.

When sifting through charts to find stocks that are setting up potential buy points, you might spot a pattern that looks like a "W." If so, it may warrant a closer look.

The double-bottom consists of two down legs. It typically starts off like a cup base, with the stock pulling back from a high, then shaping the right side. Suddenly, it turns downward again.

As it continues heading south, some shareholders may lose patience and bail out of the stock, especially if the second leg undercuts the bottom of the first leg.

Sounds scary, but that's what should occur in a sound double-bottom pattern. The low of the second leg should fall slightly beneath the low of the first leg. Undercutting the first low by 5% to 10% or so is also acceptable.

As the right side of the second leg takes shape, the W formation should become more visible. The will be located at the top right side of the second down leg, and should equal the middle peak of the W plus a dime.

As with a cup base, a can form on a . If that turns out to be the case, the buy point would then be 10 cents above the top of the handle.

Whether a stock breaks out from a handle or the top of the right side, look for a surge in as it clears the entry.

Solar Winds (SWI) more than doubled in price from its July 2010 low to its closing high the week ended June 17, 2011 1. The network management tools firm started a four-week slide before turning up.

The stock trended higher the next four weeks, forming the middle peak 2 before pausing to start the second leg. It undercut the 20.40 low of the first leg the week ended Sept. 23, hitting 19.72 in above-average trade 3.

Solar Winds rose the next three weeks before breaking out past the 25.72 buy point (middle peak plus 10 cents) the last week of October 2011. Volume ran at its biggest weekly level in nearly a year.

From there, the stock went on to rally as much as 140% over the next 11 months.