The conventional wisdom sometimes advises caution when boldness is required.
For example, when a stock gaps up out of a base, it's natural to think it's too late to buy. You'll hear remarks like this: "You should've bought it last week. After today's big gain, it's way too late to buy.
That kind of thinking paralyzes many investors.
If IBD was about momentum investing, then the too-late argument would be valid. The investor who buys a junky or mediocre stock simply because of a big price gain is assuming more risk than is prudent.
Sometimes you'll see a stock with weak fundamentals notch a big gap-up gain, often within a sloppy base. Those moves seldom hold up.
That's not too surprising. If a stock has weak fundamentals, there's no reason to buy it.
But what if certain conditions are met? What if the market is in a confirmed uptrend? What if the stock has strong fundamentals and its industry group is a market leader? What if the stock breaks out of a base in heavy volume
If those conditions are met, then the huge gap-up gain is one of the least risky stocks you can buy. Yes, it's counterintuitive to think you should buy a stock that you could've bought much cheaper a day earlier. But that's exactly what you should do.
Let's consider a few examples. (Gains were calculated from the closing price of the gap-up rather than the ideal entry that the stock skipped.) In each case, the market was in a confirmed uptrend.
A year after its IPO, MasterCard (NYSE:MA - News) gapped up 10% on May 2, 2007, clearing a saucerlike base 1. Volume was 556% above average 2. In two-and-a-half months, the stock rose an additional 38% 3. The Composite Rating was 90 on the day before the breakout.
The next day, Green Mountain Coffee Roasters (NASDAQ:GMCR - News) gapped up 9% in huge volume. The stock rose 79% further in three months. The Composite Rating was 95.
On July 20, 2007, Intuitive Surgical (NASDAQ:ISRG - News) gapped up 32%. Surely, this was too much to consider a buy. Not at all. The stock advanced an additional 71% in three months. The Composite Rating was 96.
Priceline.com (NASDAQ:PCLN - News) gapped up 22% on Aug. 8, 2007, after a quiet trip to its 50-day line. The stock rose 52% further in four months. The Composite Rating was 98.
1 comment