Holding through a stock’s significant decline that could lead to a new potential base is a challenging prospect. Who wants to sit through a potential 15–20% drawdown for an indeterminate period with virtually nothing but a belief that the stock will head higher? Yet that is one way to make long-term outstanding gains with true leaders in a healthy stock market.
Let’s take the example of Minda Industries, which had a big move in late February 2017 that lasted for about a year until its 50-day line break in early February this year.
The stock moved sharply above its buy point — a thirteen-week cup-with-handle with a 134.62 entry — on February 2, 2017, just a few days ahead of the company’s quarterly results. A strong third-quarter report sent the stock higher on February 7, 2017, with volume surging 287% above its 50-day average. However, the stock failed to trend higher in subsequent sessions and remained sideways. We added the stock to our model portfolio on February 27, 2017, when it scaled a new high on massive volume and closed in the upper range of the candlestick.
Minda Industries turned out to be the top performer of MarketSmith India model portfolio in 2017. It went on to return a whopping 157% in a period of about 13 months. While one could have booked profit much earlier but there are at least four aspects that one should factor into a decision to hold a stock long-term.
Always Check This
First and foremost is the stock’s fundamental story. Minda Industries is a well-diversified auto-ancillary company and a leading supplier of automotive components to more than 50 automobile OEMs. It has an impressive list of domestic as well as international clients, including Maruti Suzuki, Honda, Royal Enfield, Rolls Royce, Porsche, and BMW, among others.
Second, check out the company’s quarterly earnings and sales. Prior to its breakout in February 2017, Minda Industries posted three straight quarters of strong double-digit earnings-per-share and sales growth. Both earnings and sales showed a double-digit growth rate of more than 20-25%.
Third, a nice profit cushion is a requisite for holding a stock. A cup base can correct up to 15% and still be proper. Meanwhile, the math off the top can be brutal. A 15% decline erases about 18% profit, so starting off with more than a 20% gain is a great idea. The stock built a flat base pattern in March (2), but the drawdown of only 6% helped us in sitting through the base. The next consolidation came in September (3) and by that time our overall profit had reached 117%, giving us enough cushion to sit through an 11% drawdown.
Finally, patience is the last necessary quality, and only when the market is in a solid uptrend. Letting a stock idea prove itself requires the ability to focus on the macro picture and not the daily price swings from high to low.
Remember, weekly charts come first. It is easy to lose your way in the daily volatility of a stock’s action, and the weekly chart smoothes out that choppiness. A simple longer-term sell rule is the first significant close below the 10-week line (or the 50-DMA on a daily chart). Leading stocks can go months, even years, without taking out that institutional support level.
The Sell Signal
Even when Minda Industries built an 11%-deep flat base at the beginning of September 2017, the 10-week line guided the stock higher. The stock did breach its 10-week line at the end of October 2017 but on thin volumes. At that time we were sitting at a profit of 100%. You have to be willing to sacrifice a portion of your profit for greater potential upside, which underscores the importance of maintaining a lower-cost basis.
In the week ended February 2 this year, Minda Industries plunged through its 10-week line, closing down over 8% on volume almost equal to the 10-week average. It was the stock’s first significant technical weakness since the start of its move back in February, over 12 months ago.
However, we kept the stock in our model portfolio as we were sitting at a profit of 193% from our buy point of 137.55, giving the stock room for an even bigger move to the upside. But, the stock continued moving sideways and looking at the weakness in the general market we decided to book a profit of 157% on March 15. It then formed a cup-with-handle base pattern with a depth of 29% for a period of almost six months.
When to Have Conviction
It is great to have conviction, but only as long as the stock is going up. Remember, while buying a stock is primarily driven by its fundamentals, selling a stock is most definitively based on the chart. When it starts to trigger classic sell signals, it is time to listen to the stock and lock in hard-fought gains, especially when the market environment is falling apart.
If the market regains its stride and the stock constructively builds a new base, you can always buy the stock back at a new risk-optimal buy point.
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