Stage Analysis is a strategy for longer term trend trading. It was discussed in detail by Stan Weinstein in the book Secrets for Profiting in Bull and Bear Markets. Stage Analysis uses chart patterns to describe four distinct stages that a particular trade can be in. The stage, and transitions between stages, have specific guidelines for whether a trader should buy, sell, or hold the trade. This creates a simple strategy to follow when trading the market. Stage Analysis helps traders identify and stay invested in long term trends in the market.
Key Components Of Stage Analysis
Weekly Stock Chart – Weekly charts are used in Stage Analysis since the system is designed to be for longer term trading, from weeks to months to years at a time. Stage Analysis is definitely not a system for day trading.
30-Week Moving Average – The price action on the weekly chart is compared in relation to the 30-week moving average in order to determine the specific stage in Stage Analysis. Whether the weekly price and the 30-week moving average are trending higher, lower, or sideways determines the specific stage.
Volume – A key component of the transition from a Stage 1 base to a Stage 2 advance is big increase in volume on the breakout. Without a big increase in volume the breakout is more vulnerable to being a false breakout, and the market moving back down into a Stage 1 base.
Stock Market Indexes – The current stage of the overall stock market is extremely important when determining how much money to trade in the market and whether to even trade at all, or to stay in cash. When the overall market is in a Stage 4 decline, most stocks will also be in a Stage 4 decline and that is a period where a trader should play it safe instead of facing potentially devastating losses in the market.
Visual Example Of Stage Analysis
Source: Secrets for Profiting In Bull and Bear Markets By Stan Weinstein
The following discussion describes each stage in Stage Analysis, including examples from charts. Actions to be taken during each Stage are also discussed. For a more in depth discussion of Stage Analysis be sure to check out Stan Weinstein’s book.
Stage 1: Basing stage
The stock forms a long horizontal base on the chart. A base is simply a period where the stock moves mostly sideways instead of trending higher or lower. The base forms after a decline in the stock price. The longer the horizontal base the better. A long base will establish a more significant support level, and the ownership of the stock will transfer from weak hands to strong hands. The price action in the stock usually oscillates above and below the 30-week moving average while forming the horizontal base.
Actions to take in this stage:
1) Create a list of stocks in this stage, and set price levels where they would likely breakout into a Stage 2 advance.
2) Take a look at the sector the stock is in and see if the entire sector is also in the same stage. This will validate the breakout into Stage 2 if the entire sector moves with the stock.
3) Look for increased volume as the stock approaches the breakout level.
4) Do not look to take a position in stocks in this stage until the breakout into Stage 2 occurs. The reason is the stock can continue to be in the Stage 1 base for months to years at a time. Your capital will be tied up in a stock that is going nowhere if the stock stays in Stage 1 for a long period of time.
After a decline, Caribou Coffee (CBOU) formed a long base that oscillated between $1.25-$3.25. Notice how the 30-week moving average flattened out towards the end of the base.
After declining during the 2008 bear market, Ford (F) formed a horizontal base that ranged from about $1-$3.
More Notes On Stage 1:
- Volume usually dries up initially in Stage 1, but can expand later in the base as more buyers come in. This indicates that large scale selling of the stock isn't driving down the price which is a good sign.
- The basing in Stage 1 can go on for months to years
Stage 2: Advancing stage
The stock breaks out of the horizontal base and begins advancing over a period of time. The breakout needs to occur on increased volume, otherwise it might not be sustainable. The stock should also break above the 30-week moving average during the breakout. While the stock moves higher, most of the advance should occur above a rising 30 week moving average.
Actions to take in this stage:
1) The stock should be bought on the breakout or on a pullback to the breakout level.
2) The stock should be held until a Stage 3 top forms or a trailing stop is hit.
3) Trail a stop for risk management purposes. For example you can use the 30-week moving average as an area to trail a stop loss under.
4) Can also add to a long running winner in this stage as long as the uptrend continues.
Caribou Coffee (CBOU) from the previous example broke out of the Stage 1 base on a huge increase in volume. From the breakout point the stock continued to trend higher above the 30-week moving average.
Ford Motor (F) from the previous example broke out of its Stage 1 base on a big increase in volume and continued to trend higher above the 30 week moving average.
Stage 3: Consolidation/Topping stage
The stock starts to trend sideways in Stage 3 and lose momentum to the upside. The 30- week moving average also loses its upward slope and starts moving sideways. The price action in the stock usually occurs much more above and below the flattened 30 week moving average than it did in Stage 2. The stock will either breakdown into a Stage 4 decline after this stage, or after a consolidation break back into another Stage 2 advance.
Actions to take in this stage:
1) Wait for a Stage 4 breakdown to sell the stock, or just sell the stock in this stage if the technical action starts to form a significant top.
2) If the stock happens to break back into a Stage 2 advance, buy the stock back or add more shares if they still hold the position.
Starbucks (SBUX) formed a Stage 3 top after advancing for a period of time. The 30-week moving average flattened out in 2006 and the stock began oscillating above and below the moving average.
Citigroup (C) formed a Stage 3 top in 2007 when the 30-week moving average flattened out. The price of the stock moved above and below the flattened 30-week moving average during this time.
Stage 4: Declining stage
The stock breaks down below Stage 3 trading range and below the 30-week moving average in Stage 4, and continues to decline mostly below the 30 week moving average. The 30-week moving average begins a long slope downward.
Actions to take in this stage:
1) Sell positions during the transition into this stage, since they can lose considerable value if held during a steep decline
2) Stay out of all stocks in this phase
Starbux (SBUX) from the previous example permanently broke down below the Stage 3 consolidation in early 2007 and began a long term decline.
Citigroup (C) broke down below the 30-week moving average in the middle of 2007, then retested the 30-week moving average and failed to move back above it in October 2007. The 30-week moving average then began sloping downward and the stock began a long Stage 4 decline.
Stage Analysis of the Overall Market
Since the majority of stocks rise and fall along with the rest of the stock market, it is very important to know the stage the major market indexes are in. Most stocks will trend along with the rest of the market. If the major indexes are in a Stage 2 advance, you can expect the majority of stocks to also be in a Stage 2 advance. The most important thing to keep an eye on is when the overall market transitions into a Stage 4 decline. Since most stocks will be declining along with the rest of the market at that point it would be prudent to get out of long positions and stay conservative while the market declines.
- Avoid buying stocks in Stage 1 bases until they breakout into a Stage 2 advance, as sometimes capital can become tied up when a stock bases for a long period of time
- The best opportunity for buying comes on the breakout from Stage 1 to Stage 2
- Stage 3 consolidations can either form a top and lead to a Stage 4 decline, or simply a trading range that develops into another Stage 2 advance
- Never hold a stock that is in a Stage 4 decline as it can lead to major losses
- The stage of the overall market has a big influence on individual stocks since most stocks follow the trend of the market
Quotes From Stan Weinstein
"Over the years, it has become obvious to me that the more mechanical I've made my system and the less subject to judgements and emotions, the more profitable it has become."
"Fear causes you to panic and sell at the bottom, while greed motivates you to buy right near the top. These are the driving factors behind the crowd's yo-yo mentality."
"Always be on the lookout for a very large base formation. This is especially important since these formations usually lead to very extensive and long running advances."
"Just as it takes more time and energy to push a boulder up a hill than fall, so it is with stocks. Both gravity and fear bring things down in a hurry."