Extended Stock Question

...E-mail Question:
Hey Chris,

I wanted to ask you a few questions regarding the blog you posted today...

You said at the end of your blog, "You should never try and chase an extended stock." I think I might have done that a little w/ QSII. I bought @ 78.39 and as you can see today there was a gap down. I feel like it still has some strength (making weekly screens) to continue the 60-100 run, but was curious... (and I know it is somewhat of a general question, but) If you feel that a stock that you own is a bit extended do you immediately sell and take your profits? It is pretty obvious that you don't buy extended stocks very often, but it does seem to me that you are more likely to buy a stock at the time it pulls back to one of the moving averages. But I was just thinking, is a good rule to sometimes follow: buy @ pullbacks and bases, sell when it feels extended to take your profits?

Have a great day!
MSW Member

My Answer:

Currently at 10am, QSII is trading above $82 per share so you are now showing a 5% profit. I will try to answer your questions from several angles. If I own a stock that I purchased at the proper buy point (either a pivot point, a three or four week consolidation or a moving average pull-back), I will place a trailing stop to protect profits only if my profit is already above 25%. Anything less than 25% does not warrant a physical sell stop in my set of rules. Currently, I have made it known that I own HANS and entered the stock as it approached the $60-$100 range. I do not have a physical sell stop placed at this time and I do believe that the stock is extended so I may place one shortly (next few days). If I see a sharp correction or gap-down, I will place a stop to protect profits but I am letting the profit run at this point.

If I buy a stock that is extended (and I have done this) because I am human like anyone else, I will sell immediately if the stock starts to fall more than 5% below my entry area. Just because the stock drops below my entry area (which was extended to begin with) doesn’t mean that the stock is no good. It may still hold the original (correct) pivot point and allow me to get back in on a new high or a breakout on the point and figure chart.

I try to steer clear of extended stocks as I have said on many occasions and I can give you a current example using OXPS (a stock I like and a company I love). I could have grabbed it at $21 (extended in my opinion) but I missed it so I refuse to buy it at the current $24 level. In my experience, I have seen these stocks correct or pull back slightly near $20, especially when the NH-NL ratio is not super strong. In this case, the NH-NL ratio has not topped the critical 500 new highs yet during this rally so I decided not to chase the stock into extended territory. Maybe I missed OXPS at this level but that is fine because if it is as good as I think, I will grab it at the first pullback to a moving average or the first consolidation that sets up a new entry area, even if that area is several dollars higher than the current price level. I trade based on reduced risk and currently I think an entry is risky and vulnerable to a correction if bad news hits the market. In a solid bull market, I may have chased the stock thinking that it was not going to come back down even with bad news.

You ask if I should sell when a stock becomes extended. I will reply by saying this: never sell a stock for “no reason” such as boredom, because you think it is too high or because you want a small profit. Was HANS too high when I purchased it at $66 last May after a 700% gain? I didn’t think so and I was right. Recently at a split adjusted $58, I entered again even though the stock was worth $116 before the split. Is that too high? Again, I didn’t think so and now it is reaching a pre-split adjusted level of $156 ($78 today with the split). So, is $78 too high? I ride the winners and I don’t sell just because they are too extended. A good rule of thumb is to sell when the trend reverses. One way to tell if the trend reverses is if the stock drops by 20% from its highest peak during the move. Another rule I use for the $60-$100 theory is to place a physical stop at $89.89 once the stock crosses over $90 (this is to protect profits).

So, I do buy pullbacks, corrections and pivot point breakouts but I only sell when it shows a red flag such as a climax run or exhaustion gap or if it reverses trend and violates a moving average. Another great clue to a reversal is a recent leader making new highs on very low volume after making previous highs on powerful volume (this may signal churning and a possible topping area). I am looking for the big, long term moves, not the short quick gains. The big moves make you rich, not the quick little gains; they make you impatient and hesitant. Patience is the key to success if you want to make the big bucks on Wall Street.

I hope this helps and answers your questions.
Chris