Epicureans know there's a time to avoid a raw pepper or a spicy sauce that's too hot to handle. So, is there a tool that helps investors avoid stocks that may cause a big headache or epic heartburn?
Yes. Consider a stock's average true range (ATR), a new tool available to users of IBD's most advanced stock screening and charting tool, MarketSurge.
If a stock routinely rises or falls 5% to 10% or more on a daily basis, or moves 10% to 20% within its weekly range, it often becomes very difficult to apply IBD's sell rules to control risk. As most readers know, the golden rule — selling a stock if it falls 7% below your purchase price — all but guarantees that your portfolio stays intact, even amid a dry spell of trades. Cutting losses ensures the opportunity to invest in a better stock or during bullish times.
A highly volatile stock, even those in the IBD 50, however, can whipsaw you out, even while it's staging an excellent run. So, knowing a stock's average true range helps you avoid these disappointing outcomes.
What Is Average True Range?
IBD calculates average true range by taking the difference between the day's high and low, then dividing that by the prior session's closing price. In cases where a stock has gapped up sharply, IBD uses the prior day's close, not the intraday high, in order to capture the true trading range. When the stock has gapped down a lot, we use the prior day's close, not the intraday high. Doing so offers a better representation of the true range.
Prefer the 21-day moving average of ATR. You'll get a feel for how far a stock swings in price over the past four weeks.
Keep in mind that the ultimate price range can differ greatly between an intraday high and intraday low during a single trading session vs. the difference between intraday high (or low) and the prior day's close.
In general, stick with companies that show an average true range of 5% or less. According to Mike Webster, IBD's senior market strategist and IBD Live panelist, "quality stocks" can still get found among the pool of companies with an 21-day average ATR of 5% to 7%. "But once you get beyond 7%, you're getting into junk."
The accompanying table culls companies from a MarketSurge screen meeting these criteria: ATR of less than 7%; Earnings Per Share Rating and Relative Strength Rating of 85 or higher; share price of at least 25; 50-day average daily volume of at least 800,000 shares; and trading no more than 15% off their 52-week highs.
On MarketSurge, find "21 Day ATR" within the "Price & Volume" screen parameters.
Using ATR To Evaluate Growth Stocks
The stocks range from small and midcap names such as Fiverr International ($1.3 billion in market value), China hotel chain operator Atour Lifestyle ($3.8 billion) and physicians networking site Doximity to large and megacap companies Shopify, Block, Datadog and Swiss athletic shoe maker On.
Remember, highly rated stocks with an acceptable ATR do not guarantee a winning trade. Take Atour Lifestyle. On Monday, the member of IBD's lodging group rallied 11% and cleared a 29.15 buy point in a nine-week base. But the next day, shares fell 7% and tested its 50-day moving average.
Examples of high-performance companies with very low ATRs include Bank of New York Mellon, Garmin, Wabtec, Pentair and American Express. All five growth stocks hold an ATR of less than 1.7%.
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