We’ve been talking the last few weeks about the power of “going green” … i.e., buying a stock after it has already gone up quite a bit already.
Three weeks ago, we showed everyone the virtue of buying on strength. Two weeks ago, we focused on the importance of sticking with winners. Last week, we looked at a question that every investor wants to know… How Much Can I Gain?.
All of these articles have leaned heavily on the idea of momentum – the fact that stocks that are rising in price often keep rising … and stocks that are falling in price often keep falling.
We had the chance to discuss this important concept in person last week with Alexander Green, the chief investment strategist of the Oxford Club during a webinar that we hosted together for Oxford Club members.
Alexander made the point that when it comes to investing … higher prices are often predictive of even higher prices to come because higher prices mean that the stock market is actually anticipating more value creation from the company. It’s a great point.
As you know, momentum is a key component of our Stock State Indicator (SSI) system. A stock changes from red to green in the SSI system only after it has already gone up a healthy amount and has started a solid uptrend.
The team has continued our research in this area because we find it so compelling. It’s deeply ingrained in us to try to buy things that have gone down in price … to get a “deal.” Buying a stock that has already gone up a lot has been one of the hardest truths for me to accept as an investor.
So, this week we looked into when it is too late to buy a stock that has already changed from red to green. We think that you’ll find the results very interesting.
Let’s start by revisiting one of the stocks that we looked at last week – the SSI chart on Berkshire Hathaway (BRK.B). Here’s the chart that we looked at last week.
Berkshire triggered an SSI Entry signal (i.e., the SSI changed from red to green) in mid-2012 when the stock was trading for about $85 per share. After triggering the SSI Entry, the stock rose about 60% over the next three years before finally stopping out at $135.
The question we wanted to answer was, “When was it too late to buy Berkshire after the initial SSI Entry signal?” The answer was up to 2 VQ’s.
VQ is the magic number in TradeStops. It tells us how much we should expect any stock to fluctuate over the course of a year or more just because of “noise” in the stock. It’s the minimum amount of room that we need to give a stock in order to give it the best chance of making us a lot of money.
The VQ on Berkshire at the time of the initial SSI Entry signal was 12%. After the SSI changed from red to green, Berkshire went on to gain 60% or 5 VQ’s before finally stopping out again at $135.
Our research this week found that it was still a good reward to risk opportunity to buy a stock like Berkshire as long as it had not yet gained more than 2 VQ’s (24% in the case of Berkshire) after triggering an SSI Entry signal.
Here’s what that range looks on the chart of Berkshire.
The other chart that we looked at last week was Nike (NKE). Nike triggered an SSI Entry signal at about $25 back in early 2013. At the time it had a VQ of 16%. Nike went on to gain 126% or nearly 8 VQ’s before stopping out again in late 2015.
The following chart of Nike shows what the “0 to 2 VQ area” looked like for Nike.
Pretty interesting, isn’t it?
Nike had bottomed in October of 2012 below $22. It wasn’t even that volatile of a stock at the time. The VQ was only 16%. Our research strongly suggests that it would have been a solid opportunity to have bought Nike even after it had already risen as high as $33 … or nearly 50% above its $22 low.
We don’t know about you, but buying a conservative stock like Nike that’s already up 50% is not the way we think … or at least, it’s not the way that we used to think.
To buying on strength,
TradeSmith Research Team
