Investor's Corner: Don't Look For Base Patterns In Main Indexes

Here's one good reason: It just doesn't work so well. Trace a chart of nearly any index back through time. You'll find plenty of examples of double bottoms, cups with handle and other patterns that went nowhere.

Instead, you're likely to see uptrends emerging from troughs without a discernable chart pattern.

Want to try it for a breakout from an entire index? Take a look at the Nasdaq composite's chart in June 2005.

The chart was teed-up in what would be a beautiful cup-with-handle, if it were an individual stock chart. The pattern started forming a handle June 2, paused, then "broke out" on four solid weeks of volume in July (point 1).

But that, friends, is all she wrote. The brief rise collapsed into another consolidation, which spilled into yet another.

An investor chasing such faux-bases would have missed breakouts by solid stocks that came much earlier -- May 4, to be exact.

That's when the market flashed a follow-through rally confirmation.

That's when -- after the market finds itself in a correction -- at least one of the major market indexes tries to rally.

On the fourth day or later of the advance (as long as the index doesn't make a new low) look for the index to surge on higher volume than the prior session.

While not every follow-through results in a new bull phase, every bull market and significant rally has started with one.

Atlas America (NasdaqGS: - ), for example, waited until Aug. 1 to break out, then launched into an 89% gain.

There are volumes of technical analysis that do apply to index charts. Levels of support and resistance, for example, are helpful.

But for reliable topping signals, look for a build-up of distribution days.

Those are cases when the Dow, S&P 500, Nasdaq or NYSE composite fall on higher volume than the prior session.

If several distribution days occur over a few weeks, that's a sign that institutional investors are selling shares.

Also watch the action of market leaders. If the best-performing names start breaking down, that's telling. An index may tally several distribution days, but still not sink into a correction if leading stocks hold up.

The new rally in the summer of 2006 began with an up day on July 18 (point 2). The market started rising hard two days later, by Aug. 15, it was pounding ahead on solid volume (point 3).

This follow-through confirmed the rally. Like a buy point 14 a chart for an individual stock, it marks the point where you pull the trigger -- it's OK to start buying quality stocks again, provided you've researched them thoroughly.

In fact, you should start to see stocks with solid fundamentals, base patterns and institutional ownership make breakouts and lead the market into higher ground.

From the follow-through, the Nasdaq rose 24% over the next 11 months, launching a long list of winning stocks from valid bases.