When the stock market emerges from a bad episode, such as the October to late December sell-off, the stock chart often looks ugly.
For instance, the Nasdaq composite had three sloppy waves down and two minor waves up. The third wave up is the rally since Christmas Eve. Longtime students of the stock market know that the market often defines a bottom after the third or fourth wave down.
Individual investors should not avert their eyes from either an ugly market or an ugly stock.
Ugly action sometimes can hide something positive.
Not The Prettiest Of Bases
One common pattern found — after the serious selling in the market is done — is the double-bottom base. It’s not the prettiest of bases. The double bottom is shaped like the letter W and can look sloppy. The unsightly appearance can cause it to be overlooked.
Two stocks that recently appeared in the Big Cap 20 appear to be working on double bottoms.
Union Pacific Stock Chart
Railroad operator Union Pacific (UNP) has sketched a double-bottom base. The middle peak provides a potential buy point at 159.73
Note on the weekly chart how the stock’s second low in the pattern (128.08) undercut the first low (135.81). This is exactly what bulls want to see.
The second low provides a shakeout when it begins its scary descent under the first low.
Weak holders sell into the weakness. Their disappearance from the shareholder ranks makes a breakout more likely to work.
Another favorable factor on Union Pacific’s chart is the weekly closes for the past three weeks. The indexes closed bullishly high in the week’s range in two instances, and this past week the stock appeared poised to do so again.
Also, the relative strength line is at a high, which is bullish.
Adobe Stock Chart
Publishing software provider Adobe (ADBE) is working on a double bottom.
The middle-peak buy point is 260.82. That entry is about 6% off the left-side high. Recognizing the double bottom often provides a lower entry price than if it were another kind of base.
In late December, Adobe provided a shakeout. The second low (204.95) slightly undercut the first low (207.02).
In “How to Make Money in Stocks,” IBD founder William O’Neil notes, “Double bottoms may also have handles, although this is not essential.”
Sometimes a handle will form above the middle peak, which prompts questions. How does the investor know to wait?
But the investor needn’t know the future. If a breakout in strong volume occurs at the middle peak, then the investor grabs shares. If volume is insufficient at the middle peak, then the focus turns to the handle.
Of course, all of this presumes that the stock forming a double bottom is fundamentally strong. Don’t count on the chart to overcome bad fundamentals.
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