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Why Deep Cup Without Handle Holds Many Big Warning Signs

Not every trade you take is going to be a winner and that's just the way it is in the stock market. But losing trades can teach you what went wrong, so that you won't repeat the same mistakes.

On May 26, 2006, the wireless telecom products distributor InfoSonics (IFON) blew past a 12.07 (adjusted for a 2-for-1 stock split in late June) from a cup base to a record high. was more than twice its 50-day average volume and the stock closed smack at its session high.

Despite the initial positive signs and fast and furious gains that soon followed, the quickly fizzled in dramatic fashion. By June 29, it dropped to as low as 5.60, 68% off its peak.

It's tough to pinpoint the exact reason why a trade fails. Instead, investors can lower their risk of bad breakouts by buying only top-quality bases — that is, the ones with the most positive traits.

InfoSonics' cup pattern had some good accumulation on the right side and was U-shaped. The stock had strong IBD ratings. Its EPS and RS Ratings were each 99. And it had an A+ Accumulation/Distribution Rating.

But InfoSonics had some major flaws. One was its deep base. In most cases, the correction in a cup should be between 20% and 30%. In bear markets, cups could be as deep as 40% to 50%.

InfoSonics' base corrected 61%, or slightly more than double the acceptable range (1). The left side of the base took shape even as the market was in a confirmed rally for much of the first three months of 2006.

Deep corrections are bad because the stock will likely face overhead on the rebound. If a stock falls 8%, it takes just an 8.7% rise to get back even. But as losses grow, the percentage required to get back to break even grows exponentially.

Proper bases have orderly, constructive price action. InfoSonics' pattern had some wide and loose swings, especially on the left side of its base (2). You don't want to see price action that's all over the place. Finally, the cup lacked a proper , so a final did not take place ahead of the breakout.

By the time InfoSonics came close to its 12.07 buy point, it had already nearly tripled from its low of 4.63 in late March. If a stock has already made a huge move, investors should think about how much juice is left. InfoSonics bolted as much as 43% from the 12.07 entry, then reversed hard in the week ended June 9. Weekly volume was the highest ever, another red flag.