Sometimes a stock that hasn't participated in a market rally will improve its look later and be worthy of a swing trading buy. That was the case with MELI stock. But if the market rally gets in danger, you may have to cut ties with stocks early.
The Rare Relative Strength Exceptions
As a rule, we tend to gravitate toward stocks with the best Relative Strength Ratings and strong relative strength lines. But there are exceptions. Take MercadoLibre. Tight action starting in April looked like an ideal setup as the market, also tightened up. But when the market rallied, MELI stock didn't participate.
In fact, it kept bumping its head on a downward sloping 50-day moving average (1). It finally made a meaningful move above its 50-day line and breaking the downtrend in late July (2). Just before that, the Relative Strength Rating for MELI stock languished below 80.
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While that isn't ideal, there are cases where a stock basing during a market rally can show poor relative strength but may be worth a shot. Apple didn't participate in the strong rally of 2003 but instead formed a cup with handle during that time. When it broke out of its base in 2004, the Relative Strength Rating was in the 70s.
It was even worse for AutoZone. Its Relative Strength Rating was in the 20s when it broke out of a saucer with handle in 2010 after sitting out the 2009 rally off the bottom of the 2008 Financial Crisis.
But those are unusual cases. And with earnings less than a week away for MELI stock, it was hard to pull the trigger on a purchase.
Giving MELI Stock A Shot
After its triple-digit-growth earnings report, MELI stock shot up (3), it was easy to project that the move would improve its relative strength. We added MELI to SwingTrader but went with reduced position size. Why? To give MELI stock enough room to wiggle after its big earnings move meant a higher risk percentage for the trade. To avoid taking an outsized risk for your portfolio, you can simply reduce the position size of the trade.
We still took a little bit off into strength the next day to lock in some gains with a 3% profit (4). Since MELI stock started as a half position, taking a third off made it a smaller piece of the portfolio. But as the Nasdaq composite starting pulling back to its 50-day moving average we ended up exiting early (5) to keep the trade positive amid a sea of red.
Though it pulled back more from our exit, MELI stock jaunted up 5% in a day hitting 52-week highs just a couple days after our exit (6). While it might have made the exit look foolish at the time, the market has a tendency to drag most stocks with it.
MELI stock wasn't spared in that regard. Another couple days and it fell sharply below its 10-day line (7) and below our final exit. And that was on a day where the Nasdaq composite was up over 1%. It's only gotten worse from there.
So while there are the exceptions where a poor relative strength can blossom to a winner, having a market go against you as well usually proves too substantial a hurdle to overcome.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD JNielsen.
