I love Big Bases And You Should Too

Andrew Nyquist over at SeeItMarket.com asked me to contribute to his most recent series of Market Masters. It really is a privilege for me to be able to share some of the things that I've learned from my predecessors as well as from some of my own mistakes over the years. I absorb and take in so much from my technical predecessors, that it's an honor for me to add even just a little bit of value. In last year's Market Masters series I focused on how we come up with our near-term price targets when a market is in uncharted territory. This year I thought it would be beneficial to discuss the power of the big base. In addition to the price action itself, there are some momentum and sentiment characteristics that could add to the already explosive nature of these price patterns.

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by J.C. Parets     Today I want to talk about bases. This is something that rarely gets discussed for whatever the reason, but I think they can provide some of the most explosive opportunities in the market. The old saying goes, “the bigger the base, the higher in space”. But what exactly constitutes a base? What are some of the characteristics that we should look for as market participants? And why is it that the resolution from strong bases is so explosive?

First of all, what is a base? It can be described in a number of ways but I like to phrase it simply as an extended period of time where prices remain within a well-defined range with a fixed floor and a fixed ceiling. Whenever prices reach the upper end of the range, the sellers come in, but when prices get down to the bottom of the range, the buyers step up. This goes on for a longer than average period of time until it resolves itself in one direction or another.

These ranges can be sideways, or slightly inclined, but the supply and demand dynamics that create the explosive resolution remain the same. Another important aspect to remember is that these can come on time frames of all kinds. So regardless of whether you’re a long-term investor or a short-term trader, there are bases for everyone on daily, weekly, monthly and even down to intraday charts. Also, these can be found across asset classes. This is strictly a supply and demand phenomenon so the strategy can be implemented in bonds, commodities and currencies, not just in the stock market.

A recent example of a breakout from a well-defined base was in the Dow Jones Transportation Average back in early 2013. In this case, the base was declining slightly, but the upper and lower boundaries were well-defined. I think this is a great example because while the Dow Industrials were trending higher in 2012, the transports remained flat. Imagine how frustrating it must have been to be in that market?

The resolution out of this base consolidation was explosive. The Dow Transports were the big winners in 2013 and got the year off started really strong. Look how nice that uptrend became. There were barely any pullbacks for months. In fact, Transports rallied 50% from December of 2012. For an index to do that in such a short period of time is very impressive and provides us with a great example of the power of strong bases.

You see what happens in a case like this is that both the bulls and the bears become frustrated for an extended period of time. No one is winning and they just start to give up. That’s when the explosive move occurs; leaving everyone in the dust that had decided to throw in the towel. My friend Brian Shannon at Alphatrends.net has an old saying that, “if they don’t scare you out, they’ll wear you out”. I think the psychology behind these bases has a lot to do with the fact that participants are just worn out of that market and recognize the opportunity cost they’ve had to endure while waiting for a resolution. By the time the market breaks out, it’s just been too painful to remain in the trade. And that’s when you get the explosive move.

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Tags: $STUDY $DJT $IYT $TLT $TNX $ZB_F