Using Charts to Know When to Sell Your Stocks
Guidelines, Not Rules
A Dozen Growth Stocks to Watch
I’m going to continue my chart series today with the #1 request among subscribers when it comes to chart reading: How to sell better. Before I get started, there’s one major point I make every time I write about selling better-there is no magic indicator or method that is going to get you out of a stock (or the market) consistently at the right time.
I find it interesting that, when it comes to buying, investors are usually willing to go through a checklist of sorts-is the stock going up, is the market healthy, does the company have fast growth and a big story, etc. But when it comes to selling, most investors want the secret tool that will get them out at the top! Well, there isn’t one.
One fact to remember about selling is that you’re either going to sell too early, or too late-i.e., you’re never going to sell at the exact right time. But you don’t have to sell perfectly to make big money. You just need to get out in the vicinity of a stock’s top … which is much easier to do.
What I’m going to do today is list some selling guidelines-they’re not exact rules, they’re descriptions of the kind of activity you often see near intermediate-term (and sometimes longer-term) tops.
In a way, I consider them yellow flags or, to use a more morbid example, dead bodies. If you see one dead body in an alley, it could easily be due to a heart attack or something natural. Two dead bodies? Eh, it’s not conclusive, but your suspicion is raised. Three or more dead bodies? There’s little doubt foul play was involved. (I know, it’s a weird analogy, but it works.)
Similarly, with these sell guidelines, one of them could be enough to sell your position, but it’s best if you see two or three. Without further ado, let’s get to many of the things I run through mentally when determining whether to sell or to hold.
1. First is a portfolio management guideline. When my market timing indicators turn negative, I start thinking about capital preservation instead of making money-and hence, if I’m already heavily invested, I try to sell a couple of stocks right away. Said another way, if your portfolio’s overall stance is too bullish given the market environment, that is a sell signal right there, at least for your weakest stock or two.
2. One of the simplest technical tools I like to use is when a stock holds above a moving average for many weeks (say, at least six weeks and preferably more) and then breaks it, it’s usually a good idea to sell some (if not all) of your shares. The 50-day moving average is the most meaningful, but I’ve seen plenty of instances where a stock will hold its 25-day moving average for two months, and then when it breaks, it usually leads to a period of consolidation, or worse. Home Depot (HD) was a good example-it rode its 25-day line (the orange line) for months, but once it broke that in early May, it led to a three-and-a-half-month basing effort.
3. Speaking of the 50-day line, it’s about as good an indication as you’re going to get with growth stocks. If I had to follow just one tool, it would be the 50-day line. It’s far from perfect, but it’s a good trend-following measure, and some stocks can trend along it for many months.
4. As a general rule, if I own a stock and see it drop a significant percentage (the percentage would depend on the volatility of the stock, but one of the largest percentage moves in the past three months) on volume that’s quadruple average, I’m usually selling, paring back or putting in a very tight stop. I’m not talking about a stock that’s had a series of 4% or 5% upmoves and then sinks 7% on earnings-that (could) be OK; I’m talking about a stock that’s had a bunch of 4% upmoves but then sinks 14% on huge volume. That is a trend change.
5. If you have trouble selling, it’s often good to set up some rules to help you sell at least part of your position on the way up-this is called offensive selling.
a. One simple idea is to automatically sell a portion (one-quarter to one-half of your position) once your profit equals 1.0 to 1.5 times your initial risk. For example, if you bought at 100 and used an initial loss limit of 90 (10 points), you might consider selling some shares if the stock gets up to 110 to 115 (10% to 15% of profit). Yes, that can limit your profit, but it can also help you hold onto your remaining shares, aiming for a home run.
b. Chart-wise, you’ll often see a stock rise in a channel for many weeks, and then pop its head above the top of the channel. While this seems great, it’s usually a good opportunity to lighten up. (See QIHU example below.)
6. If a stock hasn’t formed a multi-week base for more than six months, it’s a sign to be more vigilant when selling. A run that big often results in some pent-up selling pressure. This was one of the reasons I started selling GameStop in 2007-it hadn’t had any sustained retreats from March through October. I’m not saying that you should sell anything you’ve held for six months; I’m saying that bases and consolidations are normal and necessary (to scare out the weak hands) during a huge advance, so if one hasn’t happened for a while, keep your antennae up.
7. You’ll occasionally see a stock’s relative performance (RP) line diverge before its peak; the stock might pull back and then run to new price highs, but the RP line won’t. Lennar (LEN) was a perfect example-notice the two pops to new highs on this weekly chart, but the RP line never confirmed.
a. A corollary to this is simply that if a stock forms a double top over a few weeks (not just a few days), and then quickly suffers big-volume selling (either one big, bad day, or a few consecutive days of elevated volume) after the second top, it’s usually best to sell, regardless of the RP line.
8. This is more of a “hold” guideline: it’s important to recognize the difference between a stock that’s extended to the upside near the start of a move versus near the end. Take Qihoo 360 (QIHU) last year, for example-coming out of the market’s May-June correction, the stock was one of the first to hit new highs and quickly found itself a large 21% above its 50-day moving average by mid-July (see first mark on the chart). That’s a sign of power, and QIHU continued to trend higher for months. Also notice how, in mid-September, the stock moved out of trend on the upside (rule 5b above) right before entering a new base-building phase (see the second mark on the chart).
9. You should keep an eye on the stock’s volatility, or the smoothness of its advance. This is hard to define (which is why I put it near the end of the list), but near a top, you’ll often see a stock that normally gyrates, say, within a two-point range, start flopping around in four- and five-point ranges … and not making any progress while it’s doing that. Such action (a pronounced pick-up in volatility after a big run) is usually a sign of distribution. We’ve actually seen this at many intermediate-term market tops, where the indexes will start chopping around for a few weeks near their highs.
For an example, look at the daily chart of GameStop (GME) from 2007 (we looked at the weekly chart earlier)-and note how it chopped for weeks between 55 and 60 after a smooth upmove. That was right near the price peak of the entire move.
10. Lastly, for those of you that use trailing stops, I am generally in favor of them. However, I prefer to think of them as “safety nets”-i.e., a worst-case sell point (assuming no huge overnight gaps). Thus, some sort of trailing stop is a good thing to have in mind, but you’ll often be able to sell better (even if it’s partial selling) using some of the above guidelines.
As you can see, there isn’t any single hard-and-fast sell rule that works in all situations, but by keeping a broad selling checklist of sorts, you can usually sniff out abnormal action as it begins to occur.
As for the current market, not much has changed during the past couple of weeks. The broad market is hanging in there, some energy stocks are in good uptrends, but most growth-oriented stocks are still languishing. The good news is that I’m finally starting to see some set-ups among growth stocks, and I’ll feel more positive about the market if a variety of these stocks can bolt above resistance on good volume.
A couple of these names are reporting earnings this week. One, AerCap Holdings (AER), had a nice report and did pop above resistance in the 44 area today; I wouldn’t call it the most decisive breakout I’ve seen, but if it can hold up here it would be a bullish sign.
GT Advanced Technologies (GTAT), which I’ve written about before, reports Wednesday evening (May 7). If it can pop above 19 or so in the days ahead, that would be bullish.
First Solar (FSLR) reports tonight (May 6), and the area to watch there is 72 to 73.
Lastly, there’s Salix Pharmaceuticals (SLXP), which reports Thursday evening; a decisive push above 114 would be good to see.
Can you buy these stocks if they push higher? Yes, but maybe just one or two, and I still advise keeping positions small-the market hasn’t confirmed a new uptrend after all. Most of all, even if you don’t buy any of these stocks, you can use them as a real-time indicator on the market’s health-if many of them bomb, it wouldn’t be a good sign for growth stocks, but if they surge higher, the market could be entering a new bullish phase.
All the best,
Chief Analyst, Cabot Market Letter
And Cabot Top Ten Trader