Watch how the best growth stocks behave soon after a strong breakout. If a true market leader with top-notch fundamentals holds firm near a certain price level for at least three straight weeks, it can give the alert investor a chance to add shares ahead of another solid price run and new highs.
XIBD has a simple name for this follow-up buying opportunity: the three-weeks-tight pattern, or simply three-weeks-tight.
But first, let's discuss what the term "follow-up buy" means.
In a bull market, the first time to buy a stock is when it clears the proper buy point of a base pattern. These patterns include the cup with handle, double bottom, flat base and base on base. If the breakout is healthy, you should establish a full-size position in the stock.
Earlier in 2019, Planet Fitness (PLNT) muscled past a three-weeks-tight with a 60.01 entry. The stock has ranked frequently within the top 10 spots in the IBD 50.
Its three-weeks-tight began to form in the week ended Jan. 25. In the next two weeks, the gym operator finished 0.7% lower and up 1.1% higher for the week. The highest price within the pattern: 59.91. Use the high in the pattern to find the right entry point.
How Many Shares Should You Buy?
The follow-up buy should only be a fraction of the full-size position, such as one-eighth or a quarter. Your level of conviction in both the market and the individual stock will help you decide how much to add. If you buy the same number of shares as the first purchase, your average cost will go up dramatically. This leaves you more vulnerable to a loss if the stock pulls back to its buy point. So be happy with a small add.
One element of a good base is quiet, narrow-range trading action — both in the size of its swings from high to low, and how it closes. A stock that closes at 40 one week, 32 the next and 39 a week later is not showing price tightness. Market players are revealing mixed views about the company's future. This can lead to false rallies.
When The 3-Weeks-Tight Usually Shows Up In Top Stocks
Let's assume a stock rallies 5%, 10% or more from its proper buy point then refuses to give up ground. Study the stock's weekly chart. If shares close at nearly the same price in prior weeks, a light bulb should shine inside your head. This behavior suggests overall demand for the stock is exceptionally high. If the difference between each weekly close exceeds 1.5%, the three-weeks-tight pattern likely has flaws.
The time to add shares usually is when the stock climbs at least a dime past the highest intraday price in the tight pattern, ideally in strong weekly volume.
Not all three-weeks-tight patterns work. A sudden spate of bad economic or corporate news can drown a stock in sellers. So could a major market top. Also, some three-weeks-tight pattern stretch into a four-weeks-tight, and the same principle apply.
The Specs Of A Three-Weeks-Tight
Limited Brands, now known as L Brands (LB), helped lead the bull market that began in August of 1982. In 1978 to 1979, the women's clothing chain suffered a huge slide from 22.50 to 4. But the stock marched back to 16 by May of 1981 before weaving a long cup with a long handle (1).
L Brands cleared its handle in three straight up weeks on accelerating volume (2). By early May, the stock climbed nearly 30% above its 15.88 buy point. Mild pullbacks to its 10-week moving average gave holders chances to add shares (3).
Buy When The Market Heats Up
In mid-August of 1982, the market indexes followed through vigorously. L Brands thrust ahead 44% in just three weeks (4). Then the stock barely budged the next three weeks (5). It closed at 28.25, 28.25 and 28. The weekly spread between the closes was less than 1%. That's tight action.
L Brands resumed its huge run in the week ended Oct. 1. The stock passed its 29.60 buy point on two days of gains on above-average trade. The rally that followed was stunning; it ramped up another 325% by July 1983, making a pair of 2-for-1 splits along the way.
L Brands corrected sharply for 11 months, built a new base and broke out again in January 1985. That breakout ushered a 465% gain over the next 2-1/2 years.
A version of this column was originally published on Aug. 4, 2010. Please follow David Saito-Chung on Twitter at both @SaitoChung and @IBD_DChung for more on chart patterns, growth stocks, breakouts and financial markets.
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