Price corrections allow you to identify whether your stock behaves like a “tennis ball” or an “egg.” Look for stocks that demonstrate tennis ball-like price action (signifying natural reactions).
Once a stock has moved above the pivot point from a constructive base, it’s time to monitor how the price reacts. This helps you decide whether to continue holding the stock. Stocks that only experience short-term corrections tend to establish new highs once they return to an uptrend. If a stock is genuinely strong and about to accelerate, the corrections will be brief and find support easily. These stocks will quickly reach new highs within a few days after returning to the uptrend. Such corrections resemble a tennis ball, hitting the floor and bouncing back even higher.
Figure 1.1 iClick Interactive ADR (ICLK) in 2020
iClick Interactive ADR corrected back to its breakout point in five days, then rebounded sharply on high volume—classic tennis ball action.
The following examples show you how to identify whether a stock is experiencing a tennis ball-style correction or an unusual correction that could threaten the uptrend.
iClick Interactive ADR achieved a successful breakout from a flat base. You can see successive corrections lasting five and eight days, followed by the stock reaching new highs. Volume surged at the initial breakout and on the rebound after each natural correction. Typically, a stock breaking out from a base will undergo a minor retracement back to the initial breakout point (or just slightly below). This is entirely normal if the stock quickly recovers within a few days or, at most, one to two weeks. Volume tends to decrease during natural corrections, then increases as the price establishes new highs.
There was minimal volatility during the initial surge and the two natural corrections. Minor corrections during an uptrend are normal and necessary for the price to build momentum for higher highs. Strong stocks bounce back quickly after natural corrections, helping you determine if you should continue holding the stock.
Figure 1.2 NVIDIA (NVDA) in 2020
After each natural price reaction, the stock quickly recovered and established new highs.
Once you purchase a stock on a breakout from a base, observe the following signals:
- Early in the uptrend, volume will generally increase over several days.
- Price often climbs sharply in the initial days, facing minimal resistance.
- Natural corrections occur with lower volume than the volume during the early uptrend.
- Natural corrections typically last only a few days or, at most, one to two weeks, after which the uptrend resumes with rising volume.
Figure 1.3 AppLovin (APP) in 2024
The stock quickly recovered and established new highs.
Figure 1.4 Advanced Micro Devices (AMD) in 2020
Refer to the book Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market