PART 2 OF 3:
Off the initial run from the IPO, the stock progressively gains a strong following of holders with high expectations. This following will peak at some point, and either an absence of buyers or a preponderance of sellers will cause the price of the stock to decline. Depending on the sharpness of the rise prior to the peak, and the conviction of the holders, the decline may be sharp or gradual. When the decline is gradual and there is only moderate volume, this is most constructive because it shows there are buyers waiting to pick up the shares at the slightly reduced price (on the slight weakness). Over a period of a couple weeks, continued action following this pattern causes the formation of the descending edge leading into the cup bottom as, ideally, a gradual concave curve. Since this once hot stock is now in a downtrend, interest in long shares declines, and the established base of holders that believe in the longer-term prospects of the company holds pat. Generally this decline should be around 15-20% (peak to avg cup bottom level) to be most constructive. Anything much greater than this has bearish implications unless it correlates to an overall market decline. The volume dries up significantly (buyers AND sellers) when at the cup bottom, with very little sustained price progress for a period of at least 3-4 weeks (at least 6 weeks total for the entire cup width). A couple of mini-rallys while in the bottom don't appear to affect the probability of the strong breakout from the handle. In other words, the bottom doesn't have to be completely flat, but the fewer undulations it has, the more constructive the bottom is. Eventually, and generally for some fundamental-based reason, interest in the stock returns. More people have found out about the company through press releases, analyst reports, friends, magazine articles, etc, and new buyers enter the picture.
Remember that the most important price of a stock, in most peoples minds, is the price they paid for it. Their view of the world revolves around that point. Also remember that most people won't take a loss in a stock-they hold on until they can "get out even." The less patient will sell on any rally off an apparent bottom. Very few, though, will sell as a stock goes sideways along an apparent bottom (which is what allows a bottom to form in the first place-in conjunction with a lack of new buyers). The longer the stock goes sideways in the cup bottom, the better. This makes the weak holders even more impatient, and does a better job of flushing the weak holders out once they can "break even." When the stock again begins to see buying interest, and begins to pull out of the cup bottom, there will often times be a selloff once the price exceeds the point where the initial downtrend into the cup began. The reason this generally occurs after the rise EXCEEDS the prior peak is because the rising edge of the cup is generally a strong, steady move-clearly more positive that the 4 weeks or so it has gone sideways in the cup bottom (and also steeper than the decline leading into the cup bottom).
END PART 2
DH |
