Better to bend than break. That is as true of people as it is of stocks.
When investors miss out on a stock rally, they wait for stocks to fall before buying them.
That is a great strategy. But you do not want the stock to fall all the way back to the buy point you missed. That is actually a weak sign. It shows the stock is not able to hold its gains because investors lack conviction in the stock.
It is better to see if the stock bends down to what are known as important levels of price support. These lines emerge just by averaging out the stock's action over several weeks. The average closing stock price over the past 50 days or 10 weeks historically has acted as a level of support. A rebound from one of these lines offers a good opportunity to buy on the dip.
The 50-day moving average can be found on IBD MarketSurge's daily charts or IBD Charts, while the 10-week moving average is plotted on the weekly charts. In both, the line is colored in red.
Finding Follow-On Entries With Moving Averages
When a rally fades, the stock may fall right through its 50-day or 10-week moving average, breaking support and triggering a sell signal.
But if the stock rebounds after testing the line, it's a sign that institutional investors are buying at cheaper prices.
When a stock tests this level of support, monitor it closely. The stock should touch the moving average or trade just above it before rising again.
Using a weekly chart, look for the week in which the stock makes its rebound from the 10-week line. The buy point is the 10-week average's price level. (MarketSurge offers this data.) The buy zone goes up to 5% from the buy point.
If the rally resumes rapidly from the support level, it is better not to chase the stock.
The follow-on buy point is usually higher than the proper buy point. That is OK because it shows that the stock is doing the right thing.
That gives investors a second chance to buy at the new follow-on entry because the stock is clearly in an uptrend.
Not every touch of the 10-week line makes for a good entry. It's best to use this trading strategy with the first or second pullback to the 10-week line after a stock breaks out of a proper base.
Amazon Stock's Amazing Rebound
Amazon.com provided a good example of buying on a pullback to the support level.
The stock broke out of a cup with handle on Feb. 16, 2017, at a buy point of 843.84 (1).
After five weeks of little price progress, shares fell and tested the 10-week moving average on March 27 (2). That gave a follow-on buy point at about 845, the 10-week average at that time. The buy zone went 5% above that entry, to about 887.25.
Institutional demand for Amazon became clear, as the stock jumped nearly 5% that week in higher volume than in the previous five weeks (3).
Investors who jumped in on the follow-on entry benefited as shares gained 28% to 1,083.31 on July 27 (4), when Amazon stock started forming the next base.
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