The stock you're watching has quietly built the right side of the base and closes within a few percentage points of the proper buy point. The next day, you're prepared to buy a stock but it jumps significantly. Blowing past the buy point or even the 5% buy range, it may seem like another missed opportunity. But a breakaway gap is a bullish signal and could be the beginning of a monster run.
A breakaway gap is an unusually strong breakout from a sound base. It demonstrates powerful investor demand, and that should not disqualify the stock for purchase. It just means you must adjust the buy zone.
With most breakouts, the buy zone goes from the buy point to 5% above it. With breakaway gaps, your goal is to buy as close to the opening price as possible. Before you make a snap purchase, take five minutes to calculate the correct buy point.
How To Buy Stocks: Adjusting For The Gap
Take a look at the stock on a five-minute chart with IBD MarketSurge, our premium charting tool, or your brokerage. If shares are able to hold above the opening price, use the high of the first five-minute bar as your buy point. This compensates for the price gap.
IBD's other trading rules apply to this adjusted buy point: Do not buy shares more than 5% above the buy point. Sell if the stock falls 7% below your purchase price.
Ideally, the stock should have the fundamentals of a true market leader. It should be No. 1 in its industry group and the market should be trending higher. Read IBD's The Big Picture column for daily updates on the current market outlook.
Breakaway gaps are typically news-driven or triggered by an earnings release. This makes IBD's earnings calendar another valuable tool to have in your toolbox.
It's not uncommon to see breakaway gaps end the day with double-digit gains. Some top-tier stocks will even post gains of 20% or higher.
Remember to use the eight-week hold rule should your stock hit the 20% profit goal within three weeks of the breakout.
How To Buy Stocks: Builders FirstSource's Gap
On May 3, 2023, Builders FirstSource jumped 12% on better-than-expected earnings in the face of unfavorable macroeconomic conditions. Builders FirstSource manufactures structural and related building products for residential construction.
The stock opened 5% up from the day prior and cleared the 96.61 ascending base entry (1). Shares topped the first five-minute bar at 104.86, creating a new entry at that level (2). From here, add 5% to find the top of the buy range, or 110.10 (3). With volume 205% above the daily average (4), Builders FirstSource closed near its session high.
From the new buy point, investors had a 17% gain over the next three weeks. Investors who felt confident enough to hold through the late-May pullback realized gains of nearly 50% before shares topped in early August.
This article was originally published Jan. 5, 2024, and has been updated.
