Basing denotes the consolidation in a security’s price. This price movement is usually employed by technical analysts and it emerges after a downtrend before reclaiming the bullish phase. The subsequent price pattern appears flat or slightly rounded, signifying that there’s an equilibrium between demand and supply. Technical analysts identify two common basing patterns that can be used to implement distinctive trading strategies to locate entry and exit points.
Additional read: Commodity market
An overview of basing
Basing often comes about after an asset or the market experiences a prolonged state of decline or is in the middle of a major upturn. Simply put, the volatility of a security starts to wear off. Certain assets like stocks can develop a base that sticks for multiple years before the trend switches.
Technical analysts opine that basing has an integral role to play in trades. This is true for stocks that particularly face a quick fall before a significant reversal manifests. Basing can also be seen as a refreshing pause that enables an asset to continue its bullish phase.
Basing phases bring a declining volume, establishing an equilibrium between demand and supply. The volatility also begins to contract as the asset trades sideways. The sideway movement of a stock or market highlights a slight change between the lows and highs of the price, rendering it trendless.
Securities embracing a basing pattern initiate a clear support and resistance level while the bulls and bears contend for control. Basing can be used by institutional traders to accrue a huge position at the behest of their clients.
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Types of basing strategies
The following are two basing strategies applied by traders.
Trend continuation: If you are using the basing period to uncover an entry point in the trending market, place a trade when the price breaks ahead of the high of the consolidated range to enter a long position. The breakout should ideally happen on an above-average volume to demonstrate engagement in the move.
The commonly utilised moving averages, like the 20-day or the 50-day moving average, serve as a foundation at the bottom of the basing period. This allows the moving average to match the price. For a short position, a moving average comes off as a resistance.
A basing formation with a narrow range facilitates a healthy risk or reward ratio. You can use a stop-loss order beneath the lowest traded price during a basing period. As the market is expected to resume its trend, setting profit targets that are multiples of the stop amount can help secure the majority of the move.
Trend reversal: Often, contrarian traders may end up using basing periods to explore potential tops or bottoms of an asset. In the case of long-term market consolidation, a breakout in the opposite direction of the last trend usually prompts stop-loss orders and draws in traders, setting the stage for a reversal.
When it comes to the trend continuation approach, if the price hits the lowest trade value during the basing period, exiting the trade would be wise. You could utilise retracements of the old trend to determine profit targets.
Additional read: Quick assets
Identifying basing patterns
Charts and trading signals outlining price fluctuations define the relative strengths and weaknesses of a security, which help the technical traders in recognising basing patterns.
There are two forms of basing patterns: the cup with a handle and the flat base.
Cup with a handle: This pattern comes to the surface in the presence of an uptrend and is linked with a deeper correction. It tends to appear close to the stock’s 52-week highs. Securities that reach an all-time high are the most suitable candidates for this basing pattern due to the absence of overhead resistance.
Flat base: This basing pattern is tied to a shallow correction. It shows up once there is a breakout rising from a deeper correction. For a flat consolidation to occur, an uptrend must establish itself, much like the cup and handle pattern.
Understanding base-on-base patterns
A combination of two bases is known as a base-on-base pattern. This phenomenon unfolds during the start of a base formation when an asset’s price does not reflect a substantial rise from its buy point. You can observe the signs of this basing pattern when a new base emerges at a point higher than the previous one, resembling two steps of a staircase.
Typically, the second base is a flat one. However, both can take any shape, including a cup with/without a handle or a double bottom. The following are some additional features that analysts look for to identify a base-on-base pattern.
- Any deviation between price levels of the first and second bases. This essentially indicates that the second level does not breach the first level’s price territory.
- The second base as the determinant when the proper buy point is concerned.
- The appearing basing pattern should be seen as a single basing pattern instead of two different ones.
- Rather than a single base-on-base trend, there are two distinct patterns that come about if the stock price breaches above 20% of its purchase point. This signifies that the second base is beginning to form.
Closing thoughts
Used by technical analysts, basing refers to the consolidation in the stock price, which often materialises after a downtrend before it proceeds to go back on the bullish course. Along with volume reduction, basing illustrates a balancing state between demand and supply. Two commonly preferred basing patterns—cup with handle and flat base—are used by analysts to execute different strategies to determine entry and exit points.
