Stocks don’t go straight up.
After a significant move higher, the surge takes a breath.
Profit-taking causes small pullbacks, which allow the stock to briefly consolidate.
This is what is known as a “base.”
The way to make money is to identify these bases…
Learn to interpret when they are coming to an end…
And buy the stock on its way out at the earliest stage of a new breakout.
(For the newest breakout surge stocks, take another look at our latest Watchlist.)
But nothing goes up forever.
Typically, a healthy stock will form three to five bases before the party comes to an end.
You can see what I mean in the chart below…
Base 1 is almost impossible to spot – at least for me.
The stock is typically near its lows after a Stage 4 selloff and mounting a turnaround.
Since it has not yet confirmed its uptrend at this point, I almost never buy them.
Base 2 is the sweet spot.
My best returns have come from buying a stock when it comes out of this base.
If done correctly, I can hold through the next base formation and catch a second surge higher.
Base 3 can be equally profitable.
Others are taking notice of the stock at this point, but there is usually still plenty of gas left in the tank.
However, once you get into Bases 4 and 5, the odds of success go down.
This is what I refer to as a “late-stage base.”
I generally only buy stocks coming out of a fourth or fifth base if the setup is extremely tight.
If pullbacks shrink to 3% or 4%, I may still take the trade since I only need to risk a few percentage points on the setup.
But I almost never take my 10% maximum risk on a late-stage base.
When Risk Outweighs Reward
As you can see from the earlier chart, Dillards, Inc. (DDS) is over a year into its uptrend.
On Wednesday, shares broke out of a textbook base formation. But I didn’t take the trade.
The risk was too large to buy a base 4 breakout.
The maximum I am willing to risk on a trade is about 9.1%.
And for me, the risk is too great for a stock this far into its surge where the odds of success are beginning to dwindle.
Sales for Dillards were up over 65% in each of the last two quarters.
Six months ago, I would have taken the trade without a second thought.
But my focus is always on risk first. And the risk is too big at this stage of the run.
A Bonus Trade to Make Today
My good friend and Traders Agency analyst Anthony Speciale recently sent me a trade he is watching on Facebook (FB).
My strategy is to buy strength at the early stages of a breakout. That’s how I trade.
But there is more than one way to skin a cat.
Plus, I’ve seen Anthony’s account statements. The boy knows what he’s doing.
Here’s his chart analysis:
Anthony is preparing to buy the dip in Facebook. He sees a pile of support near his “buy zone” below the $328 area.
The teal, black and blue lines representing daily, weekly and monthly support all exist within that zone.
He wants to buy if FB stock trades below $328, with a stop at $295 for 10% risk on the trade.
His target for the upside is $375 – 14.3% above his entry point.
But instead of buying the stock, Anthony plans to use a stock option to achieve the highest possible return.
If FB stock enters his buy zone, he will buy the FB January 21st (2022) $380 call option (FB220121C00380000), which currently trades for $9.30.