Ask Colin

How far should I should let a stocks price run after I believe it has made a break out?

The detailed question was:

I am a bit confused to as to how far should I should let a stocks price run after I believe it has made a break out. What is your philosophy on this? I will give an example of a stock I had listed, but got away from me.

Amalgamated Holding (AHD) was earmarked so that if it should breakout above 505 then I would pay very close attention with the view of purchasing.  It closed above this price on 7/11/06. To see if the breakout was the real thing (for the use of better words) I let it run and it closed at 525 on the 9/11/07. It stayed at this price until 13/11/07 where it closed at 553, which is approx. 10% gain and has been rising ever since. Is this to much of a gain to get on board if I believed the breakout has been established? The 260 day moving average was still heading up.

I know that there is no hard and fast rule as to when to get in and buy, but I have watched other stocks to the same thing, but in saying that, I have also seen other stocks fall as well.

My investment method is to buy upward breakouts or new highs in an uptrend. This is not the only method or even the right one. Many people find it hard to buy new highs like this. It is also not a good method for short term traders. Remember that I am an investor and my time frame is months to years. If you cannot buy upward breakouts or new highs in an uptrend, or you are a short term trader, you need to develop a different approach. I do not teach one, because I do not use such an approach except to the extent that I also buy pull-backs that find support in an uptrend or after an initial breakout. This is described in detail in The Aggressive Investor. If you want a short term approach to consider, I could not more highly recommend Dr Alexander Elder’s book Come into my Trading Room.

As for Amalgamated Holdings (AHD) I had no problem with it. There was a clear breakout on 7 November. I bought it on 10 November at $5.20. I cannot recall why I took a couple of days to act – maybe I was busy. It had nothing to do with waiting to see what happened. My plan is to see a breakout and buy it. I do not even think about the percentage breakout. I am looking for a big move over months to years. A few percent is irrelevant. However, if you were trading short term, you could have bought it that day or the next day at up to $5.10. It sounds to me as though the problem is three-fold:

First, how clear are you about your trading plan? Do you know your timeframe and do you have clear written rules for your entry? If you do, and you believe in them, it is easy – you just follow them. Good traders and investors do not agonise over decisions, they see the entry signal and they act without hesitation according to their plan.

Second, you may be looking for a guarantee that the breakout will succeed. I am sorry to bring you a dose of reality, but there is no such thing as a guarantee. I have never found a way to pick the ones that fail from the ones that succeed except using hindsight. The idea is that a breakout has a better than even chance of leading to a trend in the direction of the breakout, but there are no guarantees. Upward breakouts will tend to succeed more often in a bull market than a bear market, but there will always be some that fail. If it were not so, there would be no risk and you would not be able to buy the stock, because everyone else would also want to buy it and there would be few if any sellers.

Third, you may be trying to get a sort of a guarantee by waiting and watching it going up. If this is your plan, fine, but then what is the problem? I suspect that it is not a plan as such, but lack of an entry plan and conviction in following it. In fact, you may be actually increasing the pressure on yourself in a perverse way – the more it goes up, the more you worry about how far it has gone and find it even harder to buy it.

To get out of this bind, you need a clear plan, believed in with conviction. If you lack the conviction, go back and do more testing until you KNOW that it works more often than it fails. That is the best you can do. Then just follow the plan. The danger you have is not in the decision to buy. If you have good money management and trade management, it is not intellectually very difficult. The difficult stuff is the emotions in decision making. Here, my book Think Like the Great Investors may help you a lot.