Basing

What is Basing?

Basing is a term used by technical analysts that refers to a consolidation in the price of a security, usually after a downtrend, before it begins its bullish phase. The resulting price pattern looks flat, or slightly rounded.

Understanding Basing

Basing is a common occurrence after a security, or the market, has been in a lengthy decline or is in the midst of a significant advance. In other words, the market is taking a break. Some securities, like stocks, can form a base that lasts for several years before the trend reverses. Basing periods are accompanied by declining volume and there is an equilibrium between supply and demand. Volatility also contracts as a stock trades sideways.

Securities 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 position on their client's behalf. Many technical analysts believe that basing is crucial, especially for stocks that have had a rapid decline, before a meaningful reversal can commence. Basing can also be viewed as the 'pause that refreshes' that allows a security to resume its bullish move.

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Basing Trading Strategies

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 below the lowest traded price in the basing period. Since the expectation is for the market 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 traders leading to an environment that is conducive for a reversal. As with the trend continuation strategy, the trade should be exited if price breaches the lowest traded price during the basing period. Traders could use retracements of the previous trend to set profit targets.