In the summer of 2020, Tesla (TSLA), LGI Homes (LGIH), and Lam Research (LRCX) defied expectations by achieving successful breakouts despite significant flaws in their bases. These successes stood out particularly because each of these stocks had excessively deep bases, with declines from prior highs exceeding 40%, 50%, or even 60%.
Challenges of Deep Bases
Stocks with such deep chart patterns face a tough recovery journey. A 30% decline requires a 43% bounce back to recover, but a 50% fall demands a doubling of the stock price. Ideal bases involve price declines of no more than 30% or 33% from their highs over several weeks or months. However, in 2020, even stocks with deeper declines managed successful breakouts, challenging traditional market rules.
Adapting to Market Conditions
Despite these anomalies, the fundamental rules of stock bases remain unchanged. The 2020 phenomenon can be attributed to typical bear market behavior combined with the unique impacts of the COVID-19 pandemic. During weak markets, growth stocks often fall 1-½ to 2-½ times more than the market average. For example, a 20% market correction might lead to growth stocks dropping by 30%, 40%, or 50%. Nevertheless, fundamentally strong companies often rebound effectively once the market begins to rise again, regardless of their previous steep declines.
Bear Market Stock Charts
William O’Neil, the founder of Investor’s Business Daily (IBD), emphasized the importance of focusing on stocks with the least deteriorated base patterns during market declines. “Whether you’re in a bull market or a bear market, stock downturns that exceed 2-½ times the market averages are usually too wide and loose and must be regarded with suspicion,” O’Neil noted in “How to Make Money in Stocks.”
Case Studies: LGI Homes, Lam Research, and Others
LGI Homes experienced a dramatic 65.5% drop from its February 21, 2020 peak to its low on April 3, 2020. The homebuilder sector faced severe setbacks due to the pandemic-induced unemployment spike, but ultra-low interest rates facilitated a recovery. LGI Homes rebounded and broke out of a handle buy point at 95.24 on July 7, 2020, eventually climbing as much as 30% before some gains were retracted. Similarly, D.R. Horton (DHI) fell nearly 60% but began rising again from a buy point around 60.
Lam Research, a chip-equipment manufacturer, saw a 47% drop during its February-March 2020 sell-off but managed to climb as much as 25% from a 310 cup-with-handle entry. Other semiconductor stocks also experienced deep declines but still achieved successful breakouts, including ASML (ASML), which hit a 20%-to-25% profit target from its 319.22 buy point.
Reflections of the Broad Market
Stock charts and bases largely mirror the overall market behavior. The steep decline and rapid recovery of 2020 led to numerous V-shaped bases, typically considered weak formations. Yet, in the unique market conditions of 2020, these bases performed well.
Notable examples include KLA (KLAC), Tesla, and PennyMac Financial Services (PFSI), all of which demonstrated the ability of stocks to recover and break out successfully even from unconventional and deeper bases.
Conclusion
The 2020 stock market, shaped by unprecedented conditions, allowed for remarkable recoveries and breakouts from unusually deep bases, defying traditional expectations and highlighting the resilience of fundamentally strong companies in volatile times.
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