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Breakouts of long bases on strong volume are frequent harbingers of continued price appreciation. Another harbinger, after the initial up-leg, is a low-volume, orderly pullback towards support.

Kendle International (KNDL)

An analysis of Kendle International's chart illustrates this strategy. As the daily chart indicates, Kendle in February 2005 broke out of a base pattern that extended back almost two years. Some traders, who missed entering early, may have given up on the stock when it doubled by late June, but a closer look at the chart shows why it had more room to move.

Kendle's pullbacks were orderly, coming on lower volume and holding near its moving averages, a key sign of more upside to come. Only once did its pullback break beneath the 40-day moving average (in mid-April), but on extremely low volume. Otherwise, as the daily chart indicates, each pullback hugged the 21-day moving average, or, at worst, as in early July, touched the 40-day.

The pattern was breakout (February), flag, breakout (June), flag, breakout (July), flag, breakout (August), flag and a breakout again in September, where it closed the month at $28.14, more than 3 1/2 times its price before the February breakout. Volume on each pullback was a small fraction of the level of the breakout, and a shallow decline just grazing the moving averages suggested a continuation of the uptrend.

(click to enlarge)

As a stock in a rising pattern pulls back, look for several factors to portend the continuation of the pattern. First, look for very low volume on the pullback – between 10% and 25% of the average volume of the last 90 days. Second, watch for the decline to flatten near the 21- or 40-day moving average on the hourly charts in a quiet, narrow flag-type formation.

When the breakout comes, buy on the initial thrust out of this flag pattern. This means a sudden dramatic change in price accompanied by heavy volume. The price doesn't necessarily have to rise above the top of the flagpole (i.e., the previous rally high prior to the consolidation), but only needs to be a bar that is at least several times the size of the previous several bars on the chart.