Is the Stock Price Extended ?
- Rohit Musale, CFA
- 6 days ago
- 3 min read
I have figured out a way to determine whether the stock that I am buying is extended in price or not.
If I find that it is extended, I stay away from risk.
Countless times, this has helped me avoid an imminent and obvious loss.
I found the answer to this problem when I began to study 3 great human beings and trading legends:
- William O' Neil
- Mark Minervini
- Stan Weinstein
When I read Stan Weinstein's book, I understood the importance of stage analysis.
Basically, he says there are 4 stages through which any stock goes through.
Stage 1: Consolidation
Stage 2: Accumulation
Stage 3: Distribution
Stage 4: Capitulation
Stage 2 is the only time that a trader can make money.
That's what I learnt from Mark Minervini.
Within a Stage 2 uptrend, the stock forms multiple bases.
That's what I learnt from William O' Neil.
Some stocks collapse after forming 3 bases.
Some stocks collapse after forming 10 bases.
But broadly speaking, there are 5 bases on the weekly timeframe chart in a Stage 2 uptrend.
When a stock breaks out of a base, I want it to ideally travel a distance of 20 to 25%, before I start drawing the next base.
What if the stock begins to fall before that ?
Well then, the base could end up forming multiple sub-bases.
Example:
- Base 2A
- Base 2B
- Base 2C
Sometimes there are 5 sub-bases in a base.
Most of the times I have observed that there are 3 sub-bases in a base.
Not every time will a sub-base be formed.
The formation of a sub-base happens based on market conditions.
A fundamentally strong stock is ideally not supposed to form a sub-base.
However, if the market conditions are not strong, the stock will hold its ground.
Instead of collapsing, it will spend time re-forming the base.
A formation of a sub-base in a weak market in a fundamentally strong is actually a sign of strength.
Base 1 and 2 are: early stage investable bases.
Base 3 is a: trade-able base.
Base 4 and 5 and beyond are: late stage bases.
The expected return from Base 3, 4, 5 and beyond is 20-25%, but only in a very strong clear up trending market.
The expected return from Base 1 and 2 is much higher depending on how the trader manages the trade.
If the trader holds on to a stock as long as it stays above the rising 10 week SMA, the expected returns from Base 1 and Base 2 could be impressive.
Coming back to my question:
Is the stock that I am buying extended in price ?
Yes, if I am looking at Base 3, 4, 5 and beyond.
Else, I could be entering the stock at the appropriate time.
A very important point:
Base 2 does not necessarily mean an early stage base.
Base 2 does not necessarily mean that the price is not extended.
What if the stock shoots up 50% or 100% from Base 1 without forming Base 2 ?
That too is an extended stock.
A trader's understanding of the base count is crucial to his work.
A swing and a positional trader cannot ignore this vital skill of base counting.
Regards,
Rohit Musale, CFA
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