Lesson : Look For Key Reversals, Shakeouts

(from IBD.com) When poring over stock charts for proper bases, you should look for positives such as upside reversals and shakeouts.

Basically, positive reversals and shakeouts tell you that there's demand for shares. Both are good things to see on charts, and at times, they can be buying opportunities.

An upside or positive reversal is when a stock sells off and then bounces back, finishing higher on the session. A stock may open lower on disappointing earnings news, lowered guidance or a downgrade, but battle back to close higher on the day. The action is bullish and is even more so if it takes place in robust volume.

Upside reversals show strength in times of adversity. Sometimes they occur at key moving averages such as the 50-day or 200-day lines on a daily chart. They can also take place at prior lows or consolidation levels.

While positive reversals are good things to see on the daily chart, investors should also look for them on the weekly time frame. Erasing a good part of a loss and finishing in the upper 60% of the week's range in strong volume are good signs.

For stocks that stage weekly upside reversals, volume should be in above-average volume or at least up from the previous week. This could be a sign of support from institutions.

Shakeouts can come in several ways. A pullback that creates a handle can be a shakeout. The retreat scares out weak holders and sets the stock for the next leg up.

Other times, a shakeout involves a more prolonged downturn and subsequent bounce that takes place over several days or weeks.

A shakeout can also take place when a stock takes out a prior low and then rebounds. It doesn't have to close higher, but well off the time frame's worst levels. For example, the second low in a double-bottom base is a shakeout.

SunPower (SPWR) cleared a deep cup-with-handle base at 40.10 back in January 2007. The correction was 47%, which is unusually deep.

The stock staged a huge upside reversal in the week ended July 21, 2006, in big volume. (1) showing solid demand. Turnover that week dwarfed that of the prior week. The stock also staged a solid reversal in mid-June, finishing in the upper half of the week's range. (2)

The reversal week marked the 23.75 low in the base. After breaking out, SunPower rallied 310% by November the same year.