Investor Education: Learn How To Use Charts To See Sound Bases

A study of the best stocks of the past 50 years shows that they launch out of sound basing patterns on big volume.

You might think that you can get such stocks at bargain prices. Yet IBD research shows that winning stocks start their big run-ups at or near 52-week price highs.

Learning to spot these bullish chart patterns is the key to buying stocks at the right point. Visit Investors.com's IBD Learning Center. Under "Lesson on Buying," take a look at Reading Charts I and II.

What's so special about these formations? Stocks that break out from them tend to escape the kind of pullbacks that trigger sell rules.

Learning to read charts will put you ahead of other investors. Less-knowledgeable investors sometimes dismiss the movement of the stock price as random, and chart-reading as akin to astrology. But they're wrong. Charts tell the investor a story of supply and demand. They trace the pattern of fear and greed that governs the market.

Since human emotions never change, the pattern of price and volume remains the same year after year and cycle after cycle.

Imagine a stock that hits a new high, generating lots of volume. Then the stock drops 25% over several weeks and begins to move sideways. Those buyers who bought at the top are unhappy. They bought at the wrong time and failed to cut their losses. They refuse to take a loss, so they're trapped in the stock. They're the dumb money.

But wait. As the stock moves sideways, there are subtle signs of accumulation by big investors. A skilled chart reader will notice days when the stock drops to a new low only to finish near its high for the day on good volume.

It will move for days or weeks in a tight range. These big investors know that the stock's drop is a chance for them to build a big position in an outstanding company.

Some investors don't understand this. As the price rises on the right side of the base, they see a chance to get out at close to their buy price. They begin to sell, but the stock's rise is so strong it can fight through this resistance. Finally, the stock explodes to a new high on big volume. What was resistance becomes support. That is the safest place to buy.

But remember, no system is 100% perfect. You must sell any time a stock falls 7% to 8% below your purchase price. That way you'll have your capital intact the next time a winning stock sets up.