Growth stocks don’t always grow. Pullbacks and consolidations are a regular, if often perplexing, part of the process. But over time, if bought and sold correctly, most gain ground — often a good deal of ground.
One vexing trait among many growth stocks is a return to test the buy point. A leader breaks out and runs higher. Then, after a day or a week, the stock bends back to touch the buy point again, or it comes close to it.
In fact, four of 10 breakouts typically retrace their initial burst to test their buy point. In some instances, they drop below the buy point and may even test their 10-week moving average.
Growth Stocks Often Backtrack Within Days
The question of which stocks to hold and which to dump on pullbacks ventures into the art side of the investing process. And much of it has to do with your personal tolerance for risk. Growth stocks that break out with decisive moves in powerful volume engender more confidence, and seem less risky.
A pullback that occurs gradually, in weaker volume, stirs less fear of a prolonged sell-off.
In any case, pullbacks usually occur within days, rather than weeks, after a breakout. And if a stock rises more than 10% from the buy point, you should sell it before all gains are gone. Never let a double-digit gain turn into a loss.
Obviously, not all tests of the buy point succeed. So keep your sell rules in hand. A sharp break below the 10-week moving average may be enough to light up the exit sign. A 7% to 8% dip below the buy point triggers the automatic sell rule. In a squeamish market, tighten that tolerance up to between 3% and 4%.
Paylocity Stock: From Breakout To Retest, Then To Profit-Taking Zone
Share rose almost 9% above the 112.56 entry (1) in the first nine days.
A sharp, two-day pullback tested the buy point on Dec. 3 (2). Paylocity dropped back for two more tests but never threatened sell signals.
When the 10-week moving average on Paylocity’s weekly chart climbed to almost touch the stock’s low on the final dip, Paylocity turned and headed higher.
This article was originally published May 26, 2020. Find Alan R. Elliott on Twitter @IBD_Aelliott
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