Normal Pullback To The 50-Day Offers A New Buy Point
Most of the best stocks break out in the first few weeks or months of a new rally. You don't want to grab shares after they've pulled away for double-digit gains. That's called buying a stock extended.
A big winner, though, can offer a new buy point when it corrects to its 50-day moving average. Yet buying at this midterm support level takes a keen eye and steady hand to execute properly. While the rewards can be significant, so are the risks.
A stock that breaks out, then hugs its 50-day throughout a long advance without breaking that level of support, is rare. EBay and eResearch Technology have turned the trick in the current rally. A few big winners have done the same in past bull markets.
For best use of the 50-day, consider the line a thumbs up from big-money investors. Say you buy a fundamentally strong stock just as it breaks out. Turns out you picked a real winner, as the stock zooms 50%, 75% or more.
It then eases back to its 50-day in light volume. The stock's action will speak volumes. If it bounces off the line or holds near it and then shoots back up, that means institutions are rushing in to support it. If it plunges through the line in heavy trade, that support may not be there. You may need to consider selling shares.
Either way, buying right, or when the stock breaks out of its base, gives you the cushion of big gains so you can make a calm decision after a pullback to the 50-day.
Qualcomm was one of the market's biggest winners in 1999. The wireless technology firm butted against resistance for more than a year, forming a long base. It finally broke out in February 1999 1 .
The stock shot up over the next few months, trading above its 50-day. By the time it notched a new high in mid-May, it had nearly quadrupled from its breakout 2 . Qualcomm then eased back to its 50-day over the next two weeks 3 . After lifting off its 50-day, it retreated back to the line a second time, then bounced off that level of support 4 .
That kind of orderly retreat to the 50-day following a long run-up is a good time to add shares if you had already bought at the breakout. Remember that your breakout purchase should always be the biggest of any. You should buy smaller lots only further up the ladder.
Also, make sure you have a firm grasp of the key trading rules. The last thing you want to do is misstep and wipe out the big gains you've grabbed since the breakout.
Many stocks do sink below the 50-day as they form a new base. So perhaps an even better time to add shares is when it completes the base and jumps out again on solid trade. The RS line should hit new high ground. Here you can take a full stake rather than pyramid up. Great stocks form several bases, with each one higher than the previous one.
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