Mention the word "flat" in a conversation about stocks, and images of dull, laggard performance come to mind. But that's not necessarily the case with stock charts. In fact, a flat base is one of the few reliable patterns that quality stocks form before they make substantial price advances.
XWhile it may seem like a stock is going nowhere for weeks, it may be quietly winding itself up for a big climb.
Look for these characteristics to spot a proper flat base from ordinary, meaningless sideways action in a chart:
- After a prior advance, the stock declines a modest amount — no more than 15% from its prior high to its low.
- The shallow consolidation takes place over five weeks or a bit longer.
- Often a flat base develops after a stock breaks out of a cup with handle or other sound base, and climbs 20% or more from the proper buy point. Thus, flat bases usually aren't first-stage bases. They'll usually be second- or third-stage bases.
To find the buy point, look for the highest price at the start of the correction and add 10 cents.
As with any other breakout, volume should be at least 40% above the stock's 50-day average when shares climb above the entry point. The price as well as the volume should make a decisive move to new highs.
When a stock is going through this type of movement, it is quite likely that institutional investors are buying shares — adding to their positions carefully, lest they run up the price too quickly.
A Bullish Flat Base In 2010
In the summer of 2010, Rovi traded sideways for a period of seven weeks, from August through mid-September (1). That was a flat base, with the stock declining 9% from peak to bottom. The base followed an undefined pattern that spanned from late April until early July.
Price action in the base was mostly calm. When you see a chart with tight price movements, that's an indication that institutional investors are accumulating shares.
The buy point was 45.06, or 10 cents above the prior high (2). Rovi — which no longer trades publicly — cleared that level on Sept. 8 (3). Although volume was strong, the stock closed the day below the buy point. Prudent investors would have waited for a more convincing breakout.
Indeed, that day came on Sept. 20, when the stock gapped up, adding 9% as volume swelled more than four times its average (4). Shares of the company, which makes technology for TV listings, rose more than 50% to a peak on Jan. 14.
Rovi's fundamentals were sound. Earnings had risen 41% to 56% in the three quarters before the breakout. Sales growth was mediocre, but the three-year sales growth rate was 76%.
In the past few weeks, Atkore (ATKR) and Martin Marietta Materials (MLM) broke out of flat bases and are making progress. Generac (GNRC) has been a winner from a flat base breakout in January.
This column was originally published March 23, 2011. Rovi closed an acquisition of TiVo in September 2016 and adopted TiVo's name.
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