T2W Trading Community

Let’s look at each of these 4 Stages in turn :

Stage 1: The Basing Area (or Accumulation):
After a share has been declining for many months it will eventually lose its downward momentum and start to trend sideways. What’s actually happening is that whereas sellers were in preponderance, the buyers and sellers are starting to move into equilibrium. Volume will usually lessen as a base (stage 1) forms.

How it appears on the chart is that the 30-week moving average (MA) loses its downward slope and starts to flatten out. In addition, intermittent rallies and declines will toss the share above and below the MA. This basing action can go on for months, if not years in some cases.

There are two main dangers here – impatient investors will move in to catch the low price – but there is little value by so doing as your money can be tied up, going nowhere, for months or years. Even worse, premature investors can lose patience and end up selling out after months of inaction just before the big move up starts.

Stage 2: The Advancing Phase (or Uptrend)
This is the ideal time to buy a share – when it is finally swinging out of its Stage 1 base into this more dynamic stage. Such a price breakout above the top of the resistance zone and of the 30-week MA should be accompanied by increased volume (the buyers, usually the professionals, are buying the share).

The Chart will show the 30-week MA starting to curve upwards (slightly after the breakout) and this is followed by the classic uptrend picture of consecutively higher highs and higher lows as more buying takes place and others take their profits (too soon!). This is important as there will always be downside corrections mixed in with the rises. This is the market place in action – two steps forward and one back – but, so long as it is all happening above the share’s rising 30-week MA there is no need to worry (or to exit the trade) as all is in order.

Over several months of this bullish action more and more investors are becoming aware of the share and jumping on the wagon. Eventually the share will start to sag closer to its MA and the angle of ascent of the MA will start to slow down; the share is over-extended and definitely no longer a buy (but it is a ‘hold’ for you who bought it at the start of its Stage 2 rise).

Stage 3: The Top Area (or Distribution Phase)
Eventually, all good things come to an end and, in the stock market, this is takes the form of a Stage 3 top as the share loses its upward momentum and starts to trade sideways.
What’s going on under the surface is that buyers and sellers are again more or less of equal strength.

Volume is often quite heavy and the moves, up and down, can be quite ‘choppy’. The heavy volume is caused by new (and late!) buyers who are excited by the impression that the share’s bull run is likely to continue (and the ‘buy now’ stories and tips) being met in equal measure by the ‘canny’ investors who bought in at the start of the Stage 2 rise and who are now heading for the exit.

The chart shows all of this in the form of the 30-week MA losing its upward momentum and starting to flatten out. And, whereas those declines in Stage 2 all held above the MA, in Stage 3 the share price will straddle the MA – above and below it.

ShareHunter investors will often take half their profits at this stage, leaving the other half either to enjoy a renewed, late run or until the latest exit-stop price is hit.
Whatever else, this is most definitely not the time to even think about buying the share as Stage 3 is usually followed by a Stage 4!

Stage 4: The Decline (or Downtrend)
This is the stage when the factors that sustained a share’s rising price give way to fatigue and pressures caused by fearful sellers (not to mention the modern phenomenon of Hedge fund shorting).

It shows up on the chart in the form of the share price breaking down below the bottom edge of the neutral trading range that formed in Stage 3 with the 30-week MA turning downwards and the share price moving, and staying, below it.

Be aware that the ‘fundamentals’ of the share may still look in good shape; the conventional thinking is likely to be that the share is just “undergoing a correction”. This is wrong, the ‘correction’ took place in Stage 3 and the upside potential in Stage 4 is very small indeed while the downside risk is considerable. (At ShareHunter we use Stage 4 to highlight our prospects for shorting shares).