Downside Base n’ Break: A Guide to Short Selling

As stocks move through the downtrend phase of the Cycle of Price Action, they often fall below support levels and pause briefly before facing renewed resistance from declining moving averages. This pattern, known as the Downside Base n’ Break, helps identify where we are in the cycle and provides insights for traders looking to short the market.

Oliver Kell explains that recognizing the Downside Base n’ Break can keep you aligned with the trend. When weakness is confirmed, prices typically fall to new lows, consolidate briefly, and then continue their descent. This is a key signal in understanding the progression of the market’s downtrend.

Understanding the Downtrend Phase

The Downside Base n’ Break is similar to the Downside EMA Crossback, helping to track the trend between key points like the Wedge Drop and the Reversal Extension. During a downtrend, each stock and market cycle can have its own unique Downside Base n’ Break formations. The key is to understand the character of the stock or the index you’re watching.

In weak bearish trends, you might see several Downside Base n’ Breaks as stocks get repeatedly sold off. Conversely, in stronger markets, a quick reversal can happen once support is found. The best approach during this phase? Wait and observe.

Symbol: RCL
Company: Royal Caribbean Group
Year: 2023

Watching for Volatility Contraction

The general market environment will dictate how quickly a stock will consolidate its recent trend. Downtrends experience sharper selloffs due to fear, leading to higher volatility compared to uptrends where investor confidence gradually builds.

In weak market conditions, you may think the market is forming a Reversal Extension only to see the price find resistance at the moving averages, roll over and form another Downside Base n’ Break, and then make a new low. Expect heightened volatility in stocks trending below the declining moving averages.

Waiting for a contraction in volatility will present an optimal trading environment. The most profitable trades occur after a stock consolidates tightly, establishes a clear pivot point, and the overall market trend supports the direction of the trade.

The trend will still be lower until a Wedge Pop confirms the Reversal Extension. Stay patient when watching the index while screening for the strongest stocks.

Symbol: CVNA
Company: Carvana Co.
Year: 2023

How Indices and Leading Stocks Guide the Market

Leading stocks tend to signal market direction. Just as they hit new highs ahead of the broader market, they’re often the first to show weakness. When the market continues to fall below moving averages, it’s unlikely that many stocks will break out to new highs.

When the index is below the moving averages and experiences a Downside Base n’ Break, look for stocks that are finding support or making higher lows. These leaders might form an EMA Crossback to the upside, signaling potential strength even as the index continues its decline.

Symbol: ANF
Company: Abercrombie & Fitch
Year: 2023

Screening for Stocks Showing Relative Strength

Relative Strength (RS) measures a stock’s performance compared to the overall market. If an individual stock is performing better than the index it is showing RS.

Look for stocks that are further along in The Cycle Of Price Action compared to the broader market. Stocks that are breaking above the moving averages when the index is below the moving averages are showing RS and should be monitored closely.

Use the Downside Base n’ Break to the downside to monitor the cycle on the index while screening for individual stocks. The strongest stocks will hold support or even reach new highs, defying the market’s downward momentum.

Symbol: ISRG
Company: Intuitive Surgical
Year: 2023

Examples of Downside Base n’ Break Patterns

Symbol: DECK
Company: Deckers Outdoor
Year: 2021 – 2022

A gap down from highs, followed by a Wedge Drop marked the 2021 top for DECK. After a retest and failure at previous highs, the downtrend continued with multiple Downside Base n’ Breaks to the downside. March saw a possible Reversal Extension but ultimately failed with another Downside Base n’ Break. The true reversal is never known until after the fact when a Wedge Pop confirms a new uptrend.

Symbol: TMDX
Company: TransMedics Group
Year: 2023

TMDX chopped around near highs through most of 2023 until a gap down Wedge Drop confirmed a downtrend. When a stock is below the declining moving averages it is best avoided as finding the bottom can be very costly. TMDX dropped more than 60% off its highs before a monster gap up started one of the strongest moves in 2024

Symbol: MSFT
Company: Microsoft
Year: 2022

At the end of 2021, many technology stocks peaked when they couldn’t find traction into new highs. MSFT price action became extremely volatile as it whipsawed up and down. A Wedge Drop confirmed the downtrend and did not see follow-through volume on any rallies throughout 2022.

Putting it all together

The Downside Base n’ Break to the downside serves as another checkpoint within the Cycle Of Price Action during a downtrend.

A Downside Base n’ Break signifies a stock’s breakdown through a brief consolidation below the declining moving averages but more importantly, provides insight into where we are in the trend.

Patience is essential. Wait for volatility to contract before jumping in. Use this downtime to screen for stocks with relative strength. Oliver Kell emphasizes that staying disciplined and avoiding hasty decisions can make a big difference in your trading success.

By understanding these patterns and staying alert for signs of relative strength, you’ll be better positioned to navigate the market’s ups and downs.