Thursday, February 17, 2011

Readers Questions: $AHD Breakout

My question is on $AHD. I see you have a stop of 12.94 I understand this- but since it went up 1.80 today is it to late to get in and also what gains do you look for? I also did not understand what six sub- $1 and two $1-2 means when you tweet it.

Thanks for the questions - I'll start with the first one. The scans I run pick up stocks which have broken out on volume, so the $1.80 move was the qualifying action in this scan. Volume action has strongly favoured buyers, so while a 13% gain is hefty, the stock has broken into 'fresh air' and has the potential to offer much more. So is the $1.80 move too late to be getting in?

The stock closed at $15.60, so assuming you were able to buy at $15.60 next open with a stop at $12.94, your risk becomes 17% - not particularly attractive (my stops factor in the Average True Range).

Can this risk be reduced?

One can take a second look at the chart and see where the stock has broken from. Using the Open/Close range there is a former resistance level at $15.00 which dates back to its huge move in November. This resistance should now act as support, a confirmed breakout will require a test of this support and this could offer an opportunity to buy. A confirmed support test shouldn't see a close below $15.00, but intraday violations are allowed. By placing a GTC 'buy' order at $15.11 it sticks an entry 'ahead of the queue' for a support test. With a buy order at $15.11 and a stop at $12.94 the risk now becomes 13.9%. Still not great.

Next is to look for an alternative stop point. The stop suggested is an absolute stop, but it may not be the best one. Since the start of 2011 it is clear $13.50 has been defended by buyers, so setting a stop below this threshold - in this case $13.39 - offers plenty of flexibility and shaves another couple of percentage points off the risk. Now risk stands at 11.4%. Ideally, I like it under 10%, but this is a reasonable assessment for this stock

Zignals Chart Image

In practice, you can mix it up. You might decide to buy a third of your position at $15.60, a third at $15.11 and maybe try and fish for a third down in the mid $14s (a break of $15.00 at this juncture would likely trigger a series of stops - which could see prices dropping into the mid $14s before recovering; this is why intraday penetrations of support are allowed). By taking a small position on today's open you are in the game - and while the risk is high, it's offset by the smaller position.

As the trade evolves it will be important for it to sustain itself above $15. If the stock was break $15 and stay under that price for a few days, it could be reason to lighten up on the position - or sell it completely before it got to its stop. Strong breakouts don't look back, so any push back into its prior range will question the validity of the move. This is where behaviour in the broader market helps. If the S&P is rallying it will help push buyers in from the sidelines to support the move. Heavier volume selling below $15 would also be a warning sign.

At what point should a stop be raised?

This depends on what happens from here. The breakout will make a reaction top in the near future. For AHD it only took a few days in August after is break to peak at $9.69 (using the open/close as the guide - not the high/low) before it entered a consolidation phase and the same again in November when it peaked at $14.99, before consolidating. AHD has likely not peaked yet, but when it does that highest open/close price becomes the price to break for raising your stop somewhere below $15.00. One may instead prefer to trail a stop 1-3% below a moving average (e.g. 20-day MA) - you can use a Zignals stock alert to set a price cross of a 20-day MA. Or wait for a price channel to evolve and trail a stop below channel support.

By their nature, stock breakouts are volatile, so it's important the trade has room to maneuver and initial stops aren't too tight.

What gains do you look for?

Measuring upside potential comes in a number of forms. For a short-term target, project the depth of the recent base higher. So for AHD the base has a range of approximately $2 (again using open/close not the intraday high/low) for a target of $17. Using the step-by-step approach from the last breakout in early November, there is a potential $6 gain for a secondary target of $21. At that point it becomes a question as to where support/resistance lies and whether a price channel evolves. You can look to psychological levels like $25 and $30 as targets beyond the $21.

I also did not understand what six sub-$1 and two $1-2 means when you tweet it.

What I am checking for here is the quality of the stocks breaking out. When the market weakens the proportion of penny stocks topping the breakout scan increases. So I always give the total number of qualifying stocks and the number of penny stocks to get an idea of the health of the breakouts. A push to penny stocks is an indicator of greed and over-speculation. As of yet I haven't identified a threshold which would suggest it's time to be cooling off.

Hope this answers your questions!

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Dr. Declan Fallon is the Senior Market Technician and Community Director for I offer a range of stock trading strategies for global markets which can be Previewed for Free with delayed trade signals. You can also view the top-10 best trading strategies for the US, UK, Europe and Rest-of-the-World in the Zignals Trading Strategy Leaderboard. The Leaderboard also supports advanced search capability so you can tailor your strategies to suit your individual requirements.

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