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Fast Rebounds To New Highs Can Bring About Topping Action

Your mom might have told you to never judge people by their looks. But it's OK to do that with stocks.

Investors should be discriminating against bases that are V-shaped. In many cases, these are bad and they can bring about other sell signals.

Just because a stock with strong fundamentals shapes a base doesn't mean that it's an automatic buy. You still have to pore over the stock's chart and decipher the good and the bad on its price-and-volume action.

One pitfall in a base is a V-shaped appearance. This may look like good action as the stock stages a fast recovery after selling off. But sometimes this type of action is akin to being too fast, too furious. This is not healthy.

V-shaped bases don't allow a stock to go through a more natural correction. After a sharp pullback, it's good to see a stock consolidate for two or three weeks to wear out the remaining weak holders. This creates a better foundation and results in a U-shaped pattern.

While a cup or cup-with-handle base can be as short as six or seven weeks, respectively, the bases of some of the biggest stock market winners have taken months or more to form. Qualcomm (QCOM) cleared a five-month in January 1999 and staged an astronomical run.

SunPower (SPWR) blasted out of a 10-month cup-with-handle pattern in 2006 and more than quadrupled before topping.

Sometimes in a V-shaped base, a stock will fall hard for a couple of weeks and then rally for a couple of weeks of gains into new-high ground. This fast recovery into is a sell signal and means that a stock could be topping.

At times, the pullback will send the stock to its 10-week moving average, typically in heavy . This two weeks down and two weeks up sell signal generally occurs after a long uptrend.

Keep watch for variations of this sell signal. Sometimes it can be one week down, followed by two or three weeks up to a new high.

In late October 2007, Intuitive Surgical (ISRG) fell for three straight weeks (1), but found support at its 10-week moving average. The leading maker of robotic surgical systems then rose for three weeks in a row. The result: a faulty V-shaped base.

The good times didn't last, as Intuitive Surgical soon reversed lower and slumped 37% over the next few weeks before getting support at its 40-week line (2).