The number of stocks clearing sound bases has increased recently in direct correlation with the recent strength in the general markets. Stocks that have cleared a healthy base are more likely to follow through higher because the base serves as a solid foundation. A sound base often takes time to develop, and quick or choppy bases often result in failed moves as there are still many participants from the prior trend anxious to take their profits. Once a stock emerges from a healthy consolidation, the base will usually serve as a strong support or resistance level because that area is filled with other traders who missed the breakout and are anxious to avoid missing a second opportunity. (For more, see The Anatomy Of Trading Breakouts.)
Many stocks are now entering a second consolidation just above their recent bases as they pause after their recent breakouts. This is healthy price action, and typically results in a continuation move. For instance, OSI Systems (NasdaqGM:OSIS) cleared a base in September and rallied into the mid $30s. It has settled into a tight consolidation between $34 and $36 as the markets take a breather. OSIS has refused to give up much ground and could be setting up for a second leg higher. Traders should monitor the recent range for confirmation of the next move. A move above the range could lead to much higher prices, while a drop below would suggest that OSIS needs more time to consolidate.
Hersha Hospitality Trust (NYSE:HT) is another stock that has begun to settle into a consolidation after clearing a healthy base. Notice how HT is trading in a very tight range after breaking out of its base in October. These secondary consolidations often offer traders better entries than the original breakout due to the tighter range used to control risk. (For more on this topic, check out Triangles: A Short Study In Continuation Patterns.)
DigitalGlobe (NYSE:DGI) had a high volume breakout from a base in August but failed to follow through after the gap. However, DGI held above the prior base and even left a portion of the gap unfilled. DGI basically began a second consolidation after the initial breakout and appears to be close to a second breakout. Traders should monitor the top of the recent range near $33 as the breakout level.
Power-One (NasdaqGM:PWER) has been steadily rising over the past few months as it clears smaller consolidations. PWER built a base from May through July before rallying over 50% on the resulting breakout. It has now settled into a second consolidation that has remained above the prior base. Volume has picked up on the tail end of the consolidation, which could be a warning sign of a reversal, so traders should be cautious and wait for the current pattern to fully develop. The first level to watch is near $11.50, which would coincide with a declining trendline that has marked the recent pivot highs. The next level above that is the July highs near $13. (For more, see Track Stock Prices With Trendlines.)
While the general markets have been in a holding pattern, many stocks continue to develop solid basing patterns. Traders should favor the stocks that are not extended, thus offering much better risk-reward opportunities. If the markets continue to move higher, stocks that have built solid foundations will be less prone to reversals or failures. Even on a market pullback, these stocks would have a floor beneath them, which could help mitigate any weakness. Professional traders always assess risk levels first; by focusing on stocks with healthy bases, retail traders can do the same. The four stocks examined here are currently consolidating above prior bases and may offer great trading opportunities in the near future.
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At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.