In the last lesson, we discussed continuation bases. In today’s ‘part two’, we want to show you examples of bases that actually do change trends. These bases are the ‘other’ type of base, and are less common. The initial assumption should always be to play the trend, which means assuming the base is a continuation base; unless we have evidence to the contrary. Let us discuss what evidence we want to see, in order to make that decision.

These bases are tricky, because they will often ‘hold’ as a base for a long time. They go sideways in a choppy manner and are riddled with ‘failed’ breakouts and breakdowns. Traders who do not know the difference often get very aggravated. This is why bases are so ‘hit and miss’ for many traders. If you play all bases the same way, you will not get very good results. As a matter of fact, most traders will lose at bases more than they succeed, and may not even realize it.

Take a look at the chart above. It is a 15 minute chart of GARMIN LTC. (GRMN). The drop that occurred over the first two days shown was a nice decline. The question now is, whether this base will keep the price pattern heading south, or if it will ‘reverse’ the trend.

First and most important, we cannot be sure. We look for clues. When enough clues arrive, we may decide to be ‘safe’ anyhow and pass the play because breakouts are too likely to fail. What clues do we have? First, look at the move that created the base. The more that the move down was a ‘climactic one’ the more likely the base will not go lower. We see a very steep decline, and the biggest red bars coming at the end of the move, see “1”. Note the volume at the end of the move. This tells us we may have bled out the sellers, rather than have them waiting. Next notice that the consolidation goes on well past the declining 20 period moving average (see “2’). Bases that continue lower should do so in the area where the 20 period moving average catches up with the price. This base ignored the moving average and is still going. All of these concepts also apply in reverse for uptrend bases, as the uptrend base might reverse and start a new downtrend, if it also ignores the 20ma.

Here are a couple more things to look at. The volatility and volume in the base can give clues also. Low volume, low volatility IN the base means the base is more likely to be a continuation of the prior trend. On this chart the volume did pick up significantly toward the end of the base, but the base was very narrow. So overall, this last test would not have given us any clues on balance. Here is what happened to the stock.

There is also a near ‘fool-proof way’ to not get caught buying breakouts or shorting breakdowns that fail. Well, nothing if fool-proof of course, but here is an idea that helps eliminate many failures. Simply let the stock clearly breakout or breakdown, then go long after the first pullback on that time frame, or short after the first rally. We will discuss this more in the next lesson.