Sometimes you can get a strong stock but it's hard to hold because of how much it moves. The average true range (ATR) is a great way to gauge the typical movement of a stock to determine if it's one you can hold. With Toast, the larger movements made us quicker to lock in profits when we had them.
Toast Sets Up
Toast provides technology to restaurants to make their business run smoothly. You might see their products in the hands of your waiter or at the checkout when you're picking up food.
The stock looked like it formed a cup-with-handle, with an area around 24 acting as the bottom of the handle (1). We didn't enter on the initial bounce as it was an inside day (2). But as the power picked up the next session we added Toast to SwingTrader (3).
We got immediate feedback that we were on the right track with a nearly 3% gain the following day (4) and we added to the position when it broke the traditional handle buy point (5).
Our early entry helped our average cost and gave us some cushion as Toast broke out. That cushion is helpful in the case of breakout failures. But it also let us start a little more tentatively on the position since Toast had a larger average true range.
Calculating Average True Range
At its basic level, the true range takes into consideration the movement between the high and low of a stock on a given day. But since it's important to adjust for gaps up or down, it will also consider the movement from the prior day's close. Start by calculating the difference between the following points and taking the maximum value:
- The day's high minus the day's low
- The absolute value of the day's high minus the prior day's close
- The absolute value of the day's low minus the prior day's close
Once you have that daily number, you can take the average over a given period. Fourteen is the typical, but we prefer to use a period of 21 days. We also like to turn that point value into a percentage relative to the price.
Mark Minervini explains the stealth rally happening in stocks.
For Toast, the ATR was 0.96 or 3.8% at our entry (3). When Toast saw a downside reversal a week later (6), the ATR had expanded to 1.05. Still 3.8% as a percentage of the price close that day, but we had to be prepared for a larger move to the downside.
After Toast recovered back to the level of its downside reversal (7), we decided to start trimming our position.
Our Final Exit
After the Nasdaq composite got clobbered by its top stocks, it had a weak rally back to 18,000 where it hit resistance. Given the risk to the downside, we started favoring more ETFs because their ATRs are much lower. For Toast, we ended up removing the remaining position (8) to focus more on the lower ATR stocks.
It proved to be a good sell. The next day, Toast dropped sharply (9). Our desire to stave off risk led to us leaving the trade with a profit.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
