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The Cup Without Handle Can Also Yield Bullish Breakouts In Growth Stocks

To gain an edge on Wall Street, experienced IBD readers see the cup with handle as a launching pad that top growth stocks use to rocket into huge price runs. But what about the cup base that forms with no handle? Can it work as well?

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Truth is, sometimes a dynamic moneymaker is in too much of a hurry to form a handle before blasting up to new highs. Savvy investors also know how to spot a cup base that forms without a handle.

In December last year, Kirkland Lake Gold (KL) staged a great breakout from a cup without handle. Xilinx (XLNX) did the same on Jan. 24 this year. Keep in mind, though, that all breakouts stand a far higher chance of success when the current outlook for stocks is positive.

In fact, the outlook changed positively as the Jan. 4 Big Picture column noted a Day 7 follow-through by the S&P 500 the same day. The important large-cap benchmark soared 3.4%. Volume surged on the NYSE vs. the prior session. That's the stuff of heavy new institutional buys flooding Wall Street.

Xilinx ranked No. 48 in the IBD 50 in the Jan. 14 edition of IBD Weekly. After the breakout, it became one of the top performers in IBD Leaderboard.

A CAN SLIM-type investor always first pays tremendous attention to a company's profits, revenue, profit margins, return on equity and other metrics of growth. But don't look at fundamentals in a vacuum. When it comes to winning the stock trading game, precise timing is of the essence.

So it's actually foolish to ignore technical analysis, a fancy term for rolling up your sleeves and analyzing a stock's behavior via charts. When you ignore a stock's technical action, you are in effect missing out on a significant factor in what makes certain stocks great. Ignoring the "technicals" means you disregard the all-powerful forces of supply and demand that drive a stock's price day in, day out, and over much longer time periods.

How The Cup Takes Shape

As you would expect, the cup without handle resembles a U. The base starts to develop when a stock begins to decline after an advance of 20% or more from a prior successful breakout. If there was no prior breakout, demand that the stock has risen at least 30% from any given price before it forms a cup pattern.

Bill O'Neil, IBD founder and former longtime chair, says this decline often outpaces the overall market's slide. "It's normal for growth stocks to create cup patterns during intermediate declines in the general market and to correct 1-1/2 to 2-1/2 times the market averages," he wrote in "How to Make Money in Stocks."

At the same time, you want the stock to show some resilience too.

O'Neil writes: "Your best choices are generally stocks with base patterns that deteriorate the least during an intermediate market decline. Whether you're in a bull market or a bear market, stock downturns that exceed 2-1/2 times the market averages are usually too wide and loose and must be regarded with suspicion."

You want to see a drop of no more than 30% to 33%. While some cups shaped during severe bear markets can be 40%-50% deep or more and still work out, it's generally smart to focus on stocks that make shallower declines from their 52-week highs.

A cup without handle must be at least six weeks long. Most are about three to six months long, and some can span a year or longer. Prefer tight price action, not wide and loose movements, week to week. Within the base, you should see more up weeks in above-average volume (a sign of accumulation) than down weeks in fast trade (distribution).

Growth Stocks: Finding The Correct Entry Point

The buy point for a cup base is 10 cents above the high hit before the base took shape. As with any solid breakout, look for the stock to clear its buy point in strong turnover; it should jump at least 40%-50% above its 50-day average.

You can quickly see the 50-day average volume of any stock by either going to MarketSmith or viewing an IBD chart.

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Gen-Probe, an expert in diagnostic tests and blood-screening systems, went public in September 2002 and finished its debut week at around 16 a share. The stock then climbed to 28.45 by February 2003 (1), gaining more than 70%. 

The San Diego-based firm finally began its first true correction. It sank 27% from that high, then retook its key 50-day moving average (drawn in red in the accompanying chart) in mid-April.

On the last trading day of April, Gen-Probe gapped up 19%, barreling past its 28.55 trigger. Turnover that ballooned 702% above its 50-day average (2).

Growth Stocks: Strong Fundamentals At The Start

Right before that April 30 breakout, Gen-Probe showed solid IBD ratings: a 97 Composite Rating, 80 EPS, 91 RS, an A+ for industry group RS, B for SMR (Sales + Profit Margins + Return on equity) and A- for Accumulation/Distribution. In the April 30 edition of IBD, Gen-Probe got featured in "Nasdaq Stocks In The News," now called Stock Spotlight.

Gen-Probe gained 122% in 20 weeks.

Not every cup without handle will work out, especially when they show flaws. So if the stock does not act right, cut it loose and find a better investing play.

Cutting losses at 8% or less is vital to the process. Following the No. 1  sell rule in investing allows you to invest again.

A version of this column was published on July 14, 2010. Gen-Probe was acquired by Hologic (HOLX) in August 2012. Please follow Saito-Chung on Twitter at both @SaitoChung and @IBD_DChung for more on stocks, breakouts and financial markets.

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