Basing

Basing refers to a period in which a stock or other traded security is showing minimal upward or downward movement. The resulting price pattern looks like a flat line or slightly rounded. Often, 'basing' is a term used by technical analysts to describe an issue that is consolidating after a period of rapid growth or decline. A stock that is basing has equal amounts of supply and demand.

Basing is a common occurrence after a stock or the market has been in a lengthy decline or had a significant advance. In other words, the market is taking a break. Some stocks can form a base that lasts for several years before the trend reverses. Basing periods are accompanied by declining volume as prices consolidate. Volatility also contracts as a stock trades sideways. (For more, see: How Do I Identify a Stock That is Under Consolidation?)

Stocks that are basing establish clear support and resistance levels as the bulls and bears fight for control. Institutional traders may use a basing period to accumulate a large order they are buying for a customer. Many technical analysts believe that basing is crucial, especially for stocks that have had a rapid advance. They view basing as the "breather" that allows the issue to continue climbing.

Trend Continuation: Traders who are using a basing period to find an entry point in a trending market should place a trade when price breaks above the high of the consolidated range (for a long position). The breakout should occur on above-average volume to show participation in the move. Ideally, a commonly used moving average, such as the 20-day or 50-day, acts as support at the bottom of the basing period; this allows the moving average to catch up to price. The moving average acts as resistance for a short position.

The narrow range of a basing formation allows for a healthy risk/reward ratio. Traders can place a stop-loss order on the opposite side of the consolidation period. Because the market is expected to start trending again, profit targets that are many multiples of the stop amount can be set to capture the bulk of the move.

Trend Reversal: Contrarian traders may use a basing period to find potential bottoms or tops in a security. If a market has been consolidating for an extended time, a breakout in the opposite direction to the previous trend often triggers stop-loss orders and attracts breakout traders which can cause a reversal. As with the trend continuation strategy, the trade should be exited if price crosses the opposite side of the basing range. Traders could use retracements of the previous trend to set profit targets. (To learn more, see: Market Reversals and How to Spot Them.)