How To Analyze A Stock's Flat Base

During the last few weeks, we discussed all about cup-with-handle and double-bottom bases. We saw how the best stocks usually form these patterns before they make big moves. However, stocks cannot make higher highs despite their superior fundamental and growth stories. They'll go up for a while, take a breather, pull back to form a new base, and then resume their climb – giving you multiple opportunities to make money. The flat bases are a classic example in this regard, which are typically formed after a stock has made a nice gain from a Cup With Handle or Double Bottom breakout. That's why they're often considered "second-stage" bases.

Here are the key concepts to understand about [flat bases]:

• Trading Sideways to "Digest" Earlier Gains: Stocks often break out of a cup-with-handle or double-bottom pattern to run up at least 20% before essentially trading sideways to form a flat base. It's a mild decline compared with other patterns (no more than 15%). Usually, the price range remains fairly tight throughout a flat base. It may imply that institutional investors — who have to buy tens of thousands or more shares to establish a large position — are quietly buying within a certain price range. That's how they increase their holdings without significantly driving up their average cost per share.

• Support and Resistance: Again, the buy point is above the most recent area of resistance (the highest price point within the flat base). Until the stock breaks through that "ceiling" (preferably on above-average volume), it won't be able to launch the next leg of its climb.

• Shakeout: Like other patterns, flat bases also have a way of shedding weaker holders. Instead of a sharper sell-off like the handle in a cup-with-handle or the second-leg undercut in a double-bottom, the flat base shakeout is more of a slow grind. The weaker, less committed investors just get worn out by the indecisive, sideways action, and eventually, lose patience and sell.

What to Look For In a Flat Base:

• Prior uptrend: 20% or more

• Base depth: 15% or less

• Base length: At least 5 weeks.

• Ideal buy point: 0 to 5% above the most recent area of resistance (the highest price point within the flat base.)

• Volume on the day of a breakout: At least 40–50% above average

 

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