Basing

What Is Basing?

The term basing refers to the consolidation in the price of a security. This movement in price is commonly used by technical analysts and usually comes after a downtrend before it begins a bullish phase. The resulting price pattern looks flat or slightly rounded. As such, the price shows that supply and demand are relatively equal. There are two common basing patterns that technical analysts generally identify, which can be used to employ different basing strategies to find entry and exit points.

Key Takeaways

  • Basing is a trading term that is commonly used by technical analysts.
  • It refers to the consolidation in the price of a security, usually after a downtrend, before it begins its bullish phase.
  • Accompanied by declining volume, basing also demonstrates an equilibrium between supply and demand.
  • Basing securities establish clear support and resistance levels as the bulls and bears fight for control.
  • There are two basing patterns that technical analysts often identify, including the cup with (or without) a handle and the flat base pattern.

Understanding Basing

Basing is a common occurrence after an asset or the market is in a lengthy decline or if it is in the midst of a significant advance. In other words, the volatility of security begins to ease off. Some securities, such as stocks, can form a base that lasts for several years before the trend reverses.

Many technical analysts believe that basing is crucial. This is especially true for stocks with a rapid decline before a meaningful reversal can commence. Basing can also be viewed as the pause that refreshes that allows a security to resume its bullish move.

Basing periods are accompanied by declining volume and there is an equilibrium between supply and demand. Volatility also contracts as a stock trades sideways. A stock or market that moves sideways demonstrates very little change between the price lows and highs, which makes it trendless.

Securities that follow this pattern establish clear support and resistance levels as the bulls and bears fight for control. Institutional traders may use a basing period to accumulate a large position on their client's behalf. You can see this in the chart below for SunPower. The blue line indicates a base that forms before the stock's price starts to rise again in June.

Understanding Basing
Image by Julie Bang © Investopedia 2019

Types of Basing Trading Strategies

Trend Continuation

Traders who use a basing period to find an entry point in a trending market should place a trade when the price breaks above the high of the consolidated range (for a long position). The breakout should occur on above-average volume to show participation in the move.

Ideally, a commonly used moving average, such as the 20-day or 50-day, acts as support at the bottom of the basing period. Doing so allows the moving average to catch up to the price. The moving average acts as resistance for a short position.

The narrow range of a basing formation allows for a healthy risk/reward ratio. Traders can place a stop-loss order below the lowest traded price in the basing period. Since the expectation is for the market to start trending again, profit targets that are many multiples of the stop amount can be set to capture the bulk of the move.

Trend Reversal

Contrarian traders may use a basing period to find potential bottoms or tops in a security. If a market consolidates for an extended time, a breakout in the opposite direction to the previous trend often triggers stop-loss orders and attracts traders leading to an environment that is conducive to a reversal.

As with the trend continuation strategy, the trade should be exited if the price breaches the lowest traded price during the basing period. Traders could use retracements of the previous trend to set profit targets.

Incorporating technical analysis into your trading strategy doesn't happen overnight. In order to be successful and minimize your losses, you have to be able to develop your skills and practice what you learn. Check out Investopedia's online courses and training on technical analysis.

How to Identify Basing Patterns

Technical analysts are traders who use certain technical tools as part of their trading strategies. Some of these tools include charts and trading signals to map out and plot price changes that show the relative strength or weakness of an asset.

These traders are able to identify the two kinds of basing patterns: the cup with a handle pattern and the flat base pattern.

  • Cup With a Handle Pattern: This is a pattern that emerges when an uptrend is already in place and is associated with a deeper correction. As such, the price of the asset must be anywhere between 30% and 40% of the lows. The cup with a handle pattern emerges near the stock or security's 52-week highs. Any security that hits an all-time high is best suited for this pattern because there is no overhead resistance visible. Technical analysts know that assets that follow this pattern don't trade at or near their 52-week lows.
  • Flat Base: The flat base pattern is associated with a shallow correction. It comes about once there's a breakout that stems from a deeper correction. Just like the cup and handle, there must be an established uptrend in order for there to be a flat consolidation.

Base on Base

A base on base refers to the combination of two different bases. But just how is this possible? A base begins to form when the price of an asset doesn't show a major increase from its buy point. Traders can see the emergence of a new base at a point that's higher than the first one. You can see how the base-on-base phenomenon is mapped out on a chart because it looks like two steps on a staircase.

Although the second base is generally a flat base, both of them can take any form. This includes a cup with or without a handle or they can be a double bottom. There are a few other things that technical analysts look for in order to identify the base-on-base pattern.

  • There is some diversion between the price levels of the first and second bases. This means that the second base doesn't advance into the territory of the first level's price.
  • The second base is the determining factor when it comes to the proper buy point.
  • A base-on-base that emerges must be viewed as a single pattern rather than two separate ones.
  • Instead of a single base-on-base trend, there are two separate patterns that emerge if the price of a stock hits above 20% of its buy point. This is key before the second base starts to form.

Real-World Example of Basing

Remember that basing occurs when there is a consolidation in the price of a security, such as a stock. This comes after a downtrend followed by a bullish trend.

Such was the case for the S&P 500 during two different time periods when the stock market index began to form a base. In mid-2001, the value of the index began to drop, hitting a low that year in October. Slight increases in value led the index to form a base in the early months of 2002, It began to trade sideways for several months. In this case, the index dropped again after reaching its bullish base.

The same thing happened again in the latter part of 2008 and early 2009. This came after the market went through a bearish period in 2008 following the financial crisis. The value of the index plateaued before trending upward again around July of that year.

Does Warren Buffett Use Technical Analysis?

Warren Buffett is not a technical analyst and doesn't believe in using charts, patterns, and price movements to determine buying and selling opportunities, Instead, Buffett subscribes to the value investing philosophies explored by Benjamin Graham. Investors who follow this methodology seek opportunities when prices are significantly lower compared to their intrinsic values. People like Buffett determine a security's intrinsic value based on its fundamentals and tend to buy and hold rather than purchase a stock just to sell it within a short period of time.

What Is a Basing Candle?

Candlesticks are used in technical analysis and can be found on charts. Candlestick bodies indicate the open, high, and closing price of a particular security, where the wider part is known as the real body. A basing candle or basing candlestick is a trading indicator whose body length is less than half of its range between the highs and lows. That's less than 50% of its range. These candlesticks tend to develop the base of the supply-demand zones.

What Does It Mean When a Stock’s Price Flatlines?

Supply and demand determine the movement in a stock price. Prices jump when demand increases. Conversely, low demand can cause the price to drop significantly. But when the price of a stock doesn't move at all—that is, when it flatlines—it indicates very thin trading activity. As such, there isn't enough buy-and-sell activity to cause movement in the price. Stocks whose prices flatline move sideways so the range is fairly stable and there are no distinct price patterns that emerge.

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