No one wishes to take losses fast in the stock market — especially in the top stocks. But seasoned IBD readers know that at some point you'll take a lump.
IBD's golden rule of investing is this: Cut your loss if the stock falls 7% below your purchase price. But can you do better than that? Can you find clues that the stock isn't acting right, then get out with a smaller loss?
Absolutely. Splunk offered a good example in 2018, ahead of the market's plunge in the fourth quarter that year.
The Big Data analytics expert (which was acquired by Cisco Systems in March) jumped past a 112.76 buy point on May 8 in a strange-looking cup base.
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At first glance, it may have the look of a cup with handle. The decline on the cup's left side? A mild 16%. Good. But the lowest price within the handle (1), or 96.28, nearly matched the cup's own low of 94.39.
That's a flaw.
A handle marks the final shakeout of weak shareholders before a stock breaks out and runs into new high ground. But that handle should form in the upper half of the cup, not the lower half.
Let's say you go for it, anyway. You buy shares right at 112.76. At day's end, 1.65 million shares exchanged hands. By itself, that's a lot. But turnover actually was 16% below Splunk's 50-day average (2).
Disappointing? Yes. You want to see volume soar on the breakout day. On an IBD daily chart, the volume bar should vault well over the red line draped across the volume bars. That red line shows average turnover over the past 50 sessions.
Look for at least a 40% rise vs. the 50-day average on the breakout day, or in the next few days.
One More Rally, But Mostly In Low Turnover
Splunk failed to see such a strong gain in healthy turnover. Instead, in the next few weeks the stock reversed lower in heavy volume, jabbing a few times below the 112.76 buy point. On May 25, Splunk dropped more than 5% in enormous volume (3). If you sold at the day's close at 110.26, your loss would have been only 2.2%.
In the next day, the stock fell 1.7% but refused to clip the 50-day moving average. Then shares made a decent run-up and hit a new high of 121.64. But volume came in below average on many of those up days. At the peak, volume grew as the stock closed in the lower half of the day's range (4).
That action resembled a negative reversal. When Splunk reversed lower again in mid-June, it offered multiple chances to exit the stock at break-even or salvage a small profit.
Splunk dropped 7% on June 22 and plunged right through the 50-day line. Volume soared (5). That day, Splunk also triggered the 7%-loss sell rule.
A version of this article first appeared in July 2018 and has been updated. Please follow Saito-Chung on Twitter at @SaitoChung and @IBD_DChung for more on growth stocks, charts, buy points, sell signals, and financial markets.
