Sell Rules: Change of Trend

Transcription

1 How to Recognize SELL SIGNALS Sell Rules: Change of Trend

2 How to Recognize Trend Changes In this last booklet on selling rules, we ll look at how to recognize a stock s change in trend. It is always best to sell into strength, psychologically as well as financially; in other words, selling on a stock s move up in price. Stocks don t always cooperate, however, and sometimes the signals don t come until they have already topped and begun a downtrend. It is critical that you recognize these later signals because stocks that have had a strong move up can find themselves with a very quick and steep descent. Keep in mind that the sell rules listed below are to be used as a means of locking in profits on a stock that has had a significant run, rather than just breaking out of a base. Earlier in a stock s move you might sell it just to nail down a profit of 20-25%. This is the amount most stocks go up before they begin to form another base. You will also be defensive by cutting your losses while they are small by not letting a loss get more than 7-8% as a maximum from your purchase price. If you start taking losses that are even greater than that, the numbers quickly work against you. For example, a stock that goes down 8% only requires you to gain 8.7% to get back to even. A stock that goes down 25% requires a 33% gain to get back to even. And if you let a stock get down 50% from your purchase price you will need a 100% gain just to get back to your starting point. You can t make progress in your portfolio if you don t cut your losses when they are small. It also bears repeating that the vast majority of your sell decisions will be based on technical analysis. The price and volume action of the stock chart, not the earnings or sales of the company, will get you out of a stock properly. Don t be fooled the fundamentals will often look great, perhaps even their best, while the stock is topping. Locking in profits Change of Trend On a weekly logarithmic chart you can draw an uptrend line over several months, connecting the lows of at least three points. The more points you have, the more established the trend. When the stock closes below this uptrend line for the week, it is a sign the trend has changed. When a stock breaks the 50-day (or 10-week) moving average price line, I ll usually wait to see where it closes before making a sell decision. Frequently, institutions will take this pullback as an opportunity to defend or support the stock by adding shares. But if it breaks the line on huge volume or it falls below the line significantly (more than 15%), I will usually take action. The increase in volume indicates institutions are selling rather than supporting the stock. 2

3 Many times a stock will break below the 50-day moving average line but not significantly. The stock price may just hover just below the line for a number of weeks. If the stock ends up living below the 50-day moving average line for over 8-9 weeks consecutively, this shows a lack of support and signals a trend change. A flip in the number of consecutive down days relative to the up days can also be a sign that there has been a trend change. For instance, you may see four or five days down, followed by two or three days up, whereas before it would have been the opposite. Large one-day price drops should also be studied carefully. When you see the greatest one-day price drop since the beginning of the move consider selling if confirmed by other signals. Finally, significant drops in either the daily or weekly price occurring on the heaviest volume of the entire move should also get your attention. Especially when the stock closes at or near its lows. A final point on selling you should understand that selling doesn t have to be an all or nothing proposition. You might sell a portion as you see early signs of weakness to reduce your exposure and then sell the remainder of the stock as you see evidence of a change in trend. However, if the stock recovers from the weakness, you can buy back some of the shares you sold but you ve held on to your shares that you bought at a lower cost. It will be these skills in managing your portfolio that will allow you to adjust to the action of the market. As always, you can see more educational examples in Investor s Corner in IBD. Plus, visit our web site, Investors.com, to view more samples in the Education section and the Daily Stock Analysis video. The chart on the next page gives you definitions of key features included in IBD chart examples. You can use it as an additional reference as you go through this booklet. We look forward to helping you become a more successful investor. William J. O Neil 3

4 4 Sanfilippo John B & Son Increased 206% in 17 Weeks Thick black line means stock closed at a higher price than prior week s close Thin gray line means stock closed at a lower price than prior week s close Weekly Chart High Close Low 10-week moving average line 200-day moving average line Average weekly volume line Weekly volume bars Relative Price Strength Line vs. S&P 500. Uptrending line means stock is outperforming S&P 500.

5 5 J D S Uniphase Increased 2016% in 66 Weeks Weekly Chart Ideally, you would have recognized the climax top and sold into the strength Stock no longer gets support at 10-week line; lock in profits before they disappear 10-week moving average line acted as support during entire run Excessive stock splits over a short time frame

6 6 Rite Aid Increased 421% in 71 Weeks Weekly Chart Even if you sold earlier, the stock gave you another buy opportunity that was very profitable Lack of support as stock breaks 10-week line decisively Significant break of 10-week line on heavier volume Stock gets support and is able to rally back above 10-week line by the end of the week Volume much heavier as stock price breaks 10-week line Stock split Volume increase as stock price breaks 10-week line

7 7 Intercontinental Exchange Increased 152% in 23 Weeks Weekly Chart Loss of support Bad break on very heavy volume Price contained by 10-week line throughout move Highest weekly volume in stock s history as stock price breaks 10-week line Light volume m on rally, not institutional support

8 Eresearch Tech Increased 447% in 38 Weeks Weekly Chart Breaks 10-week line on huge volume Entire move contained by 10-week line Three stock splits in 18 months Heaviest volume in stock s history comes on break of 10-week line 8

9 Eresearch Tech Daily Chart Daily charts are useful for additional sell signals Largest oneday price drop Even larger oneday price drop on heavier volume Trend change - more consecutive down days than up days Support po at 50-day line Heavy volume on bad break and largest one-day price drop Heaviest volume in stock s runcomes on break of 50-day line 9

10 Pulte Homes Increased 733% in 47 Weeks Weekly Chart Breaks 10-week line on increase in volume Move contained by 10-week line Two stock splits in under a year Increase in volume on break of 10-week line 10

11 Pulte Homes Daily Chart Breaks of 50-day line on heavier volume Trend change - more consecutive down days than up days Stock never touches 50-day line during uptrend Increased volume on break of 50-day line Heavier volume on another break of 50-day line 11

12 12 Novell Increased 373% in 61 Weeks Weekly Chart Break of uptrend line on heavier volume gives a slightly earlier signal in this case Uptrend line uses at least three points drawn over several months Increase in volume on break of uptrend line

13 13 Novell Daily Chart Largest one-day drop Stock is now finding resistance at 50-day line This is where the stock breaks weekly uptrend line. Remember, uptrend lines are only drawn on weekly logarithmic charts

14 14 Apple Increased 596% in 97 Weeks Apple went on to make another run of 135% in 68 weeks after breaking out again Weekly Chart Another buy opportunity as stock breaks out after forming large 8-month base Breaks 10-week line on increase in volume Increase in volume on break of 10-week line Volume continues to increase as stock loses support

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