"Big Bases" Create Long-Term Opportunities

The market remains a hot mess where we're preferring market-neutral trades, however, some absolute trades are appropriate when the reward/risk is skewed heavily in our favor.

We outlined some favorable longs and shorts earlier today.

Another way of skewing the reward/risk in our favor is by looking for "big bases."

The way we learned it is the bigger the base, the higher in space and this is certainly a big base. And the reason we like looking for base breakouts in this environment is two-fold.

First off, big bases take time to form because they are caused by steady institutional accumulation. Mom and pop investors aren’t the ones creating this type of pattern, so we know that there’s underlying demand that will support prices if they do move lower.

Because prices have memory and the base has taken a significant period of time to build, there’s likely been more trading at each price level along the way. As a result of this institutional support, the rate of change to the downside is likely to be less severe versus a name that’s advanced quickly to the upside with less trading activity at each level, and thus less memory among market participants to defend these levels on the way down.

Secondly, our risk is extremely well-defined when trading these patterns. In the event that we are buying a base breakout (or pullback), we know exactly where we are wrong and can generally minimize our risk relative to the potential reward.

Additionally, if stocks with these bases are breaking out to new highs it is a sign that buyers are in control of their long term trend which is typically not something we see in an environment where equities as an asset class are doing poorly.

If that’s the case, we want to be participating, but if stocks continue to struggle and the breakout never triggers, it’s somebody else’s problem.

Bharti Airtel has been an awesome example of this concept in action. It broke out earlier this month and has been off to the races since.

Now, let's get into some long-term breakouts that can be held for months, quarters, and potentially years.

Here's Alembic Pharmaceuticals, which just broke out of a 5-year base to new all-time highs. Any weakness towards 765 can be bought with a long-term price target of 1,325.

Click on chart to enlarge view.

Base breakouts don't always have to be to new all-time highs. Cadila Healthcare Ltd. confirmed a bearish to bullish trend reversal by closing back above 295. Any and all weakness towards that level should be viewed as a buying opportunity, with a price target back at its all-time highs of 545.

There are also setups that haven't triggered, like Britannia Industries, which has been consolidating sideways for two years. A breakout above 3,530 would signal the continuation of its long-term uptrend and target 5,685.