The concept of compounding is a brilliant one — even when it comes to growth stocks.
You perform this when buying more shares in stocks that dish up fat dividends. Or when you reinvest capital gains in a mutual fund or high-yield exchange traded fund with new shares. So, how do you compound your gains in high growth stocks? Two steps are key.
First, buy a high-quality stock on the breakout from a solid cup with handle, double bottom, flat base or other proper chart pattern. The market should be in a confirmed uptrend; find out for sure in The Big Picture.
A brilliant stock rockets above the entry. Then at some point, it catches its breath. That’s good. A mild pullback keeps all parties to the stock honest. The stock may then rebound off the 10-week moving average at a higher price than the original breakout. When you see the rally resume, it’s often a sterling opportunity to add some more shares to your core position.
How To Buy Growth Stocks With This Chart Tool
Never used the 10-week moving average before? Don’t fear. It simply graphs the average closing price over the 10 past trading weeks. Once a new trading week is done, a new 10-week average is calculated. That’s why it’s a “moving” average.
Coherent (COHR) offered great chances to add to a winning play after a January 2016 breakout from an 11-week base at 69.77 — 10 cents above the high on Nov. 5, 2015 — that was part of a long saucer base.
The industrial laser expert rallied 40% over 12 weeks to 99.82, then pulled back.
The stock crossed back above the 10-week line in May (1) around 91.68. This was an aggressive entry because shares had fallen sharply below the 10-week line. Indeed, the stock sank back from this area. But in early July (2) there was a more classic entry near 91.75 as shares held mainly above the 10-week line.
As it turned out, Coherent was forming a new base while it found support at the 10-week average. That led to a breakout later.
One could have added shares at the July pullback. How many? Consider a quarter or a third the size of your core stake. The buy zone in these cases starts with the 10-week moving average on the week the stock finds support. In Coherent’s case, that was 91.75. The buy range goes 10% from there, or 100.93.
A stock sometimes is so strong that it rises 50%, 100% or more without even pricking the 10-week moving average. Instead, perhaps the stock traded tightly for weeks. Perhaps a three-weeks-tight or four-weeks-tight entry point unfolds. A strong advance that follows may offer the precise follow-on entry.
Ideally, the stock will rebound in heavy or increasing volume. If trading is light, focus on the price action. Does the stock quickly mop up recent losses and rally to new highs? If so, your stock is showing vigorous demand from the institutional crowd. You’re likely to not only see a nice gain in the first shares you bought, but additional profits in the second wad of shares.
Wilder stocks may test investors’ mental strength and discipline by going all the way back to the initial entry. But the rebound may offer a second chance to buy properly.
This article was originally published Nov. 27, 2019. Please follow Saito-Chung on Twitter at both @SaitoChung and @IBD_DChung for additional commentary on growth stocks, breakouts, chart analysis and financial markets.
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