Filed Under:
Tickers in this Article: YUM, FDO, DTV, PLCE
The number of stock prices clearing healthy bases has increased recently, as the general markets have been able to clear some resistance levels. Building a healthy base serves an important function for a stock, as it allows for a rotation among stockholders from those with weak hands to those with strong hands while the stock trades sideways. When a stock hasn't had enough time to rest, it creates a situation where too many participants are sitting on profits and are anxious to take them on any weakness. This leads to failed breakouts and increased volatility. This consolidation allows for normal profit-taking and introduces new participants that may be willing to hold out for more profit. Bases that form too quickly or have wide ranges will often result in failed moves. Once a stock emerges from a healthy consolidation, the base will usually serve as a strong support or resistance level (for short setups). IN PICTURES: 7 Tools Of The Trade

Yum! Brands (NYSE:YUM) is a good example of a stock that has emerged from a healthy base. YUM cleared a base in March and rallied almost 10%. It began to see profit-taking and experienced some volatility as holders began to sell, and traders who were looking to get in started to buy. Notice that as time progressed, the volatility died down and YUM began to trade in a narrower range. When sellers quietly back away like this, it is a sign of a healthy base. Once YUM cleared the base, it had a higher chance of success because adequate profit-taking had already occurred in the stock. YUM is now trading in a tight range above its base, which also shows that holders are not really selling into the move up. (For more about a strategy that takes advantage of sideways momentum, see Price Consolidation And The Long Straddle.)

Source: StockCharts.com


DIRECTV (Nasdaq:DTV) also recently cleared a base and is holding in a tight range above the breakout area. Like YUM, DTV also started out with some volatility, but settled down in late summer as volume decreased. It was able to clear the breakout area near $40 in mid-September and has now settled into a tight range just under $42. While it may come back for a retest of $40, overall the price action is constructive and the breakout appears to be valid.

Source: StockCharts.com


The Children's Place Retail Stores (Nasdaq:PLCE) is just starting to emerge from a healthy base after clearing the $50 level last Friday. PLCE had a very sharp rally this spring as it ran from $35 to $50 in just a few weeks. This is the type of move that needs time to consolidate, as there were many participants sitting on huge profits. Notice how the first batch of profit-taking in late April through early May was quite sharp as PLCE shed $10 in a couple of weeks. Buyers who missed the rally were waiting for an opportunity, which sent PLCE right back to $50. The next wave of profit-taking took longer, as PLCE drifted back toward $40 all summer. PLCE rose steadily over the past few weeks and after a tight consolidation near $50, it was finally able to break out. This consolidation (with a low near $47.50) is the level that needs to hold in order for the breakout to remain valid.

Source: StockCharts.com


Family Dollar Stores (NYSE:FDO) is an example of a stock that broke out of a base that was probably a little too quick. FDO traded in a wide range between May and July, forming a base. It cleared this base in late July, but was unable to make much progress after the breakout. However, despite the lack of upside momentum, FDO has continued to consolidate, but now in a much tighter range while holding onto its breakout. This is very positive action and FDO just recently began to emerge from this second base. (For further reading, see Family Dollar's Good Times Keep Rolling.)

Source: StockCharts.com


Bottom Line
Each of these stocks has cleared an important level recently, which is the first step toward emerging into a new trend. Often a stock will retrace from the initial breakout to test the breakout level again before heading higher. This makes the breakout level the most important area to watch in the near term. If the markets continue to hold above their recent resistance levels, these stocks are likely to follow through on their breakouts and head higher. With a healthy base beneath them, they should be able to sustain the breakouts that have occurred thanks to all the participants committed to the stock.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

comments powered by Disqus
Trading Center