How Long Should You Wait In A Stock That Moves Sideways After You Buy It?

“A picture, they say, is worth a thousand words. But to the successful investor, a picture in the form of a stock chart is worth a lot more. And not just in words.” – William J. O’Neil, MarketSmith Founder

By now, most investors would have figured out that the Indian stock market has indeed undergone a character change.

From a free-flowing upward trending market in 2017, we are now seeing high volatility leading to choppy movements.

Against this backdrop, frontline indices have failed to make much progress in the past four months.

Such periods of uncertainty could result in a build-up of impatience and frustration, which in turn could lead to sub-optimal decision making.

The toughest challenge in investing is managing the grey areas properly. The grey areas are like fog. Clarity takes time to unfurl.

Imagine a stock that you have been watching for a long time breaks out in strong volume. You buy some shares.

And then the stock stutters, retreats off its highs and begins to move sideways. Suppose the stock chops around indecisively for a week. Do you sell it? How about two weeks or three weeks? Just when do you abandon such a stock?

What would MarketSmith founder William O’Neil advise? In “How to Make Money in Stocks,” O’Neil proffers this guideline:

“When a stock breaks out of a proper base, after its first move up, 80% of the time it will pull back somewhere between its second and its sixth week out of the base. Holding for eight weeks, of course, gets you through this first selling squall and into a resumed uptrend, and you’ll then have a better profit cushion.”

O’Neil also writes, “In a few cases, you may have to allow 13 weeks after your first purchase before you conclude that a stock that hasn’t moved is a dull, faulty selection. This, of course, applies only if the stock did not reach your defensive, loss-cutting sell price first.”

Eight weeks? Thirteen weeks? That is probably more patience than most people would have guessed. But if a stock is not flashing sell signals, patience makes sense. Not every stock is going to move perfectly in line with the market. Some stocks get caught in a patch of fog, and it takes time for the fog to lift.

The Case of Indraprastha Gas

indraprasth_MarketSmithIndia

Indraprastha Gas broke out of a 14-week long cup-with-handle base pattern in the week ended April 22, 2016, clearing a split adjusted 116.84 buy point (1).

Following the breakout, the stock remained sideways for quite a few days as the Indian market went into Under Pressure. However, the stock displayed resilience as it continued to trade above the 50-day line.

In the first six weeks after the breakout, the stock pulled back to 5% under the buy point. No sell signal was triggered, but the sideways action tested the patience of new investors.

With the Indian market getting back into a Confirmed Uptrend and an improved investor sentiment, Indraprastha Gas witnessed massive buying interest on June 14, 2016, as the stock galloped 5% on almost 6x the 50-day average volume.

And then, there was no looking back. At the eight-week mark (2), the stock was 6% above the buy point. By week 13, the gain was 6.5%. Either way, there was no reason to sell.

Eventually, the gain climbed to 179% in 19 months.

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