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Why You Should Pay Close Attention To The 5% Buy Zone After A Breakout

November 14 2020
So, you missed a stock at its breakout. But since it boasts strong fundamental and technical ratings across the board, it's OK to chase it beyond the buy zone, right?

That depends on how far past the buy point you get in. The further beyond the buy point, the greater the risk of getting shaken out of a stock. MSI can help investors pinpoint the ideal time to buy. Terms such as "buy range," "buy zone" and "extended" are all related to the buy point. You'll see these terms, which CAN SLIM investors are familiar with.

Here's How To Spot The Buy Zone

Let's start with the buy range, also known as the buy zone. That refers to the 5% margin above a proper entry point. Investors should try to buy in this zone after a stock stages a solid breakout from a base. Of course, it's always best to buy as close to the actual buy point as possible. But the buy zone serves as a guideline for when a stock is deemed too extended to purchase. Once a stock gets past the 5% cutoff, it's considered extended.

To Chase, Or Not To Chase?

Why 5%? Following a breakout, many leading stocks tend to pull back to test their buy point or their 21-and 50-DMA. Setting the cutoff at 5% allows for such pullbacks without tripping the 7%-8% loss-cutting sell rule. If a stock falls 7% to 8% below your entry price, that's an automatic sell signal.

When O’Neil was asked that you say don't buy any stock that has risen more than 5% past its buy point. What's magical about 5%? 

He answered that: When we buy a stock as it breaks out, we cannot be absolutely sure this stock will be a winner. In fact, if only half of your stocks are profitable, you can still do quite well provided you cut your losses short and let your winners run. Because cutting losses short is so essential, we always sell a stock if it falls 8% from the price we bought it. This is where the 5% rule becomes important. If you buy a stock that is extended above its buy point by more than 5% (let's say 10%) then it retreats to its buy point, you will have to sell it to avoid breaking the 8% loss rule.


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Read our last week’s article:Breakouts: Key to Materialize Gains


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