Chip equipment leader Lam Research was one of the top stocks of 2020, having advanced 75% from a proper buy point during last year's stock market rebound. And it all started with a cup with handle, one of the bullish chart patterns that the biggest stock market winners form at the start of their rallies.
At its purest form, a cup with handle is simply the result of human psychology, as well as institutional support and resistance. Being able to identify a cup with handle — along with the other common chart patterns — is the fundamental building block in how to buy stocks and make money in the stock market.
Elements Of The Cup With Handle
A successful base must first have a prior price uptrend of at least 30%. Lam Research did more than that when it rallied more than 113% off its lows in March 2020 to the cup-with-handle's left side high price of 387.70 in August. From there, the stock declined as much as 24% (1), as it formed a 13-week cup with handle. The minimum length of this base is seven weeks. Ideally, the drop from the highest price within the base to the low will range from 12% to 33%.
After a sharp move up the right side of the cup in September and October, the stock quietly added a handle to the base. A handle needs at least five trading sessions, or one week, to form. Volume should quiet down. Lam's handle was two weeks long ahead of the Nov. 4 breakout.
From high to low, the handle's depth was 13%. Normally, they are between 8% and 12% deep. The handle represents a final shakeout before the stock can burst above the buy point and notch new highs.
When Lam Research surpassed the 382.06 proper buy point — a dime above the highest intraday price within the handle — on Nov. 4, 2020, the stock's action was indecisive. Volume was below average and the stock closed under the buy point. But shares closed near the top of the day's range, indicating strong demand into the close.
The next day, the stock jumped back into the 5% buy zone, surging 5.1% to close at 399.71. The following day, the stock moved out of buy range and never looked back. Shares went on to rally 75% to 669, the peak price on April 8, 2021.
Ahead of the breakout, the chip leader's fiscal first-quarter earnings and sales grew 78% and 47%, respectively, vs. year-ago levels.
After The Breakout: Follow The Rules
Just two days after the Nov. 4, 2020 breakout, shares were already past the 5% buy area. With a bit of a cushion, you can afford to be patient and let the stock move play out. But, like always, be mindful of potential sell and hold rules: the 7%-8% loss-cutting rule, the round-trip sell signal, 8-week hold rule and the 20%-25% profit-taking zones.
When a stock drops more than 7% below the proper entry, that's the stock market telling you the timing isn't quite right for this stock idea and to cut your losses. You can always buy it back later if it breaks out again.
A round-trip sell signal occurs when a stock erases the entirety of a double-digit gain from a correct buy point. Don't panic over a missed opportunity. Instead, use the round trip-sell rule to avoid further losses.
The 8-week hold rule says that if a stock breaks out, then rises 20% or more from the proper buy point in one, two or three weeks, don't sell. Instead, try to hold it for eight weeks. The eight-week rule allows you to give a potential market leader a chance to really grow in price. You want that 1,000% winner, right? Hold it for two months. Then assess the chart.
According to IBD research, once a stock hits the 20%-25% profit zone, investors should take at least some profits, but you don't have to sell the entire position. You have a sizable profit cushion to let the stock be a potential big winner. As always, be on the lookout for a follow-on buying opportunity. They include three-weeks-tight formations and a rebound off the 10-week moving average.
Be sure to follow Scott Lehtonen on Twitter at @IBD_SLehtonen for more on growth stocks, sell signals and the stock market.
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