Credit: Shutterstock photoEven the biggest stock market winners have to catch their breath at some point. So, one of the most common shapes etched during constructive price pullbacks is the cup-with-handle pattern .
But sometimes a dynamic moneymaker is in too much of a hurry to form a handle before blasting up to new highs. So savvy investors also need to know how to spot a cup-without-handle base.
Yes, investing is mostly about fundamentals. This means a CAN SLIM-type investor also pays tremendous attention to a company's profits, revenue, profit margins, return on equity and other metrics of growth.
But don't look at fundamentals in a vacuum. When it comes to winning the stock trading game, precise timing is of the essence. So it's dangerous and actually foolish to ignore technical analysis, which is just a fancy term for rolling up your sleeves and studying a stock's behavior via a simple chart.
William J. O'Neil, IBD's founder and chairman, has said that about 80% of investing is fundamentals, while 20% has to do with chart analysis. At other times, O'Neil has called it 70% fundamentals, 30% technicals. Whatever the precise recipe of factors, if you ignore price-and-volume action, you are clearly missing out on a significant factor in what makes certain stocks great.
Ignoring the "technicals" means you disregard the all-powerful forces of supply and demand that drive a stock's price day in, day out, and over much longer time periods.
How The Cup Takes Shape
As you would expect, the cup without handle resembles a U.
Some cups resemble a V, but you should avoid those because they're more prone to failure. In any case, the base starts to develop when a stock begins to decline after an advance of 20% or more from a prior successful breakout. If there was no prior breakout, demand that the stock has risen at least 30% from any given price before it forms a cup pattern.
O'Neil says this decline often outpaces the overall market's slide. "It's normal for growth stocks to create cup patterns during intermediate declines in the general market and to correct 1-1/2 to 2-1/2 times the market averages," he writes in his best-seller "How to Make Money in Stocks."
At the same time, you want the stock to show some resilience too.
O'Neil writes: "Your best choices are generally stocks with base patterns that deteriorate the least during an intermediate market decline. Whether you're in a bull market or a bear market, stock downturns that exceed 2-1/2 times the market averages are usually too wide and loose and must be regarded with suspicion."
You want to see a drop of no more than about 33% to 35%. While some cups shaped during severe bear markets can be 50% deep or more and still work out, it's generally smart to focus on stocks that make shallower declines from their 52-week or all-time highs.
You also want the cup without handle to be at least six weeks long. Most are about three to six months long, and some can span a year or longer.
Keep in mind that tight price action is preferable to wide and loose movements. In addition, there should be more up weeks in above-average volume (a sign of accumulation) than down weeks in fast trade (distribution).
The buy point for a cup base is 10 cents above the high hit before the base took shape.
As with all breakouts, look for the stock to clear its buy point in strong turnover, meaning trade that's at least 40% above its 50-day average.
You can quickly see the 50-day average volume of any stock by either going to MarketSmith or viewing an IBD chart .
One medical stock that formed a cup base is Gen-Probe.
The maker of diagnostic tests and blood-screening systems went public in September 2002.
Gen-Probe climbed to 28.45 by February 2003 (1) and then corrected, falling as much as 27% from that high.
The stock proceeded to consolidate for more than two months. Savvy investors were watching to see if the stock would clear its buy point of 28.55 in strong volume - or if it would tack on a handle to create a cup-with-handle base.
Gen-Probe went with the first option. On the last trading day of April 2003, the stock gapped up 5 points, or 19%, barreling past its 28.55 trigger in turnover that ballooned 702% above its 50-day average (2) .
Right before that April 30 breakout, Gen-Probe showed solid IBD ratings: a 97 Composite, 80 EPS, 91 RS, an A+ for industry group RS, B for SMR (Sales + Profit Margins + Return on equity) and A- for Accumulation/Distribution. In the April 30 edition of IBD, Gen-Probe got featured in the Nasdaq Stocks In The News column, which is now called Stock Spotlight . You can track this column by going to the "Stock Lists" section on the home page at Investors.com.
The San-Diego-based firm gained 122% in 20 weeks.
( Editor's note: A version of this column originally ran in the July 14, 2010, edition of IBD. Gen-Probe was acquired by Hologic ( HOLX ) in August 2012. )
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
