Tight trading within a base is bullish, but what exactly is tight
In "How to Make Money in Stocks," IBD Chairman and founder William J. O'Neil defines it this way: "On a weekly chart, tightness is defined as small price variations from high to low for the week, with several consecutive weeks' prices closing unchanged or remarkably near the previous week's close.
Visually, this means the price bars will be short and the hash marks close together.
O'Neil explains further: "If the base pattern has a wide spread between the week's high and low points every week, it's been constantly in the market's eye and frequently will not succeed when it breaks out.
"However, amateur chartists typically will not notice the difference, and the stock can run up 5% to 15%, drawing in less discriminating traders, before it breaks badly and fails.
A breakout from a sloppy base often will continue the same wide-and-loose trade. This makes the stock tough to hold and also likely to break apart more quickly than an investor might expect.
Tight action does the opposite. There's little backtracking as the stock rises. This makes it easier to add to the position at appropriate prices. The lack of severe backtracking also makes it easier to sit and wait for gains to build.
Panama-based airline Copa Holdings (CPA) launched its initial public offering in late 2005. After three up weeks, the stock began to consolidate.
As Copa declined, disciplined investors were patient. Buying while a stock is still forming the base is risky because there's no way to know whether the stock will dive deeper or continue shaping a base and eventually break out.
Copa had good fundamentals. In early August 2006, IBD reported that earnings grew 33%, 46% and 42% in recent quarters. Revenue jumped 68%, 68% and 69%.
By mid-August, Copa had traced a base within the larger consolidation (1). The potential buy point was 24.35.
Note the tight trading areas within the base (2).
The breakout came in the week ended Aug. 18 (3).
After liftoff, Copa soared 173% in six months.