Late Stage Bases

...Here is a question I received today that may relate to many of you:
“I have a question. IBD and O'Neill talk about how breakouts from 4th or late stage bases can be faulty. How do you know that it's in a late stage base. If the stock has been around awhile, isn't it likely to have had a number of uptrends and a number of levelings off?”

Late stage bases always happen with a stock after several years of up-trends. The builder stocks are the prime example right now. Early last year, the education stocks were the example (COCO, CECO, APOL). A forth or fifth stage base does not have to fail, it can be successful but based on O’Neil’s study of past stocks, these late stage bases have a higher probability of failing. In the stock market, the main focus is to lower your risk making me agree with O’Neil when he says to beware of late stage bases. Take a look at the builders and then the three education stocks above. They all had many up-trends and pattern building stages since 2000-2001. I owned a good deal of Corithian College earlier this decade and have vast knowledge about the company and stock but have not looked back at the stock in great detail since the sell. It does not mean that I can’t buy the stock again but it has not crossed my screens so I don’t bother. If COCO started to cross my screens in 2005, I would not hesitate to buy it again if the opportunity presented itself.

Once a late stage base fails and undercuts the previous base, the counting starts from one again and it is no longer qualified as a late stage base. Base counting is a gray area if you follow some examples in O’Neil’s books. The builders are amazing and have been for years (since 2000). I would not be surprised to see them breakout again but they are in late stage bases as clearly seen on the longer term charts. Failure has a greater chance now than it did 3 years ago in this sector. Play with the odds in the market because no one knows what will happen but lowering your risk will always allow you the chance to make greater profits.

Bases can go back several years as was the case with the commercial services/education stocks. You may not be familiar with these stocks as they have not made screens in the past two years but I always talked about these stocks on past forums and articles. I was in love with this sector in 2002, especially when we were still in the bear market. As for builders, take a look at the 5 year chart on bigcharts.com. The site is free with a java chart that will allow you to look at detail with an interactive touch. Looking at a 5-year chart for HOV (K. Hovnanian) which is hitting new highs as we speak, an investor can see the five bases that have formed with the recent base (pattern #5) currently breaking out from a condensed cup shape. Set the chart to the 5-year option with weekly bars. Even using monthly bars, an investor will clearly see at least four bases. You will notice that each base stays above the prior bases which allows the number to creep higher. If a late stage base failed and broke down, the number count would start fresh from one.

This was the case with Corithian Colleges (COCO) and the action that I witnessed in early 2004. The late stage base failed and the stock took a steep dive lower than the previous base, resetting the number to one. Corithian is now building a new base but sits well below the all time high and has not made any recent screen on MSW. Please take a look at this 5-year chart to see how many bases formed and then the stock finally collapsed after a tremendous run. If you do not have access to the charts, I will try to post a case study detailing both HOV and COCO so you can spot a late base breakdown in the future.

Piranha