Breakfast is the most important meal of the day. A good start is crucial to a good finish. The same goes for stock investing. Starting a position at the correct time will maximize not only your profits, but your ability to withstand a pullback.
↑X NOW PLAYINGHow To Find A 10-Bagger Stock
The buy zone — the price range in which it's best to buy a stock — goes from a stock's buy point to 5% above it. Buying above this range means you're leaving gains on the table, and you're exposed to a normal pullback.
The buy point is determined by the stock's base, and the buy points differ from pattern to pattern. The flat base uses the left-side high; double-bottom bases use the middle peak of their W-shaped pattern; and the cup-with-handle base will use the highest point in the handle.
While they appear to be different at first glance, all buy points denote the same thing: an area of past resistance. A stock's ability to clear that price point is the signal that large moves lie ahead.
Using this method,investors who follow IBD rules seem to defy conventional wisdom when they buy stocks at what could be their highest price to date. Yet, research shows new highs often extend stock gains.
Stock Investing Requires Good Timing
Once you identify a breakout, your goal is to buy as close to the actual buy point as possible. Oftentimes, the best leading stocks will pull back and test their buy points. The closer you are to the buy point, the more room you will have before you face a sell rule: a 7% drop from your entry. Every percentage point above the actual buy point is an additional percentage of risk of this sell rule that you take.
Start as close to the buy point as possible and use the remainder of the 5% buy zone to add shares.
In 2021, Builders FirstSource (BLDR) formed a cup with handle base with a 52.72 buy point (1). The building products company crossed the buy point on Aug 25. Because volume was below average on the breakout, BLDR followed with choppy, sideways action.
Uncomfortable though it may be, if your entry was good, you need not worry. The buy range went from the entry to 5% up, or 55.36 (2). The Sept. 20 low of 50.59 was only 4.2% below the buy point (3). That's well away from a 7% sell signal, and shares held above the 50-day moving average.
Subsequent pullbacks never got too serious. If you held tight, your reward came on Nov. 4, 2021, with the company's earnings report. The stock gapped up, and eventually peaked at 86.48, a 64% gain from the entry.
This article was originally published March 18, 2022, and has been updated.
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