Let's say you're sitting in a stock that has enjoyed a long winning streak. You're reluctant to sell, despite some signs that the big run is finished. When do you absolutely, positively have to sell?
XIt's at this time that the 200-day moving average (or a 40-week moving average on a weekly chart) comes in handy.
A moving average, which calculates a stock's average closing price over a set time period, shows a stock's general price direction. The 50-day and 200-day moving averages are widely used indicators of intermediate and long-term trends, respectively.
The 200-day average is found by adding the closing prices of the last 200 sessions and dividing by 200, then repeated the next trading day. Doing that creates a line that puts a stock's day-to-day action into context and helps to identify long-term support.
Most investors sell when a stock breaches the 50-day line in high volume. In many cases, they're not sitting on a big enough profit to risk further loss of hard-earned gains. But investors who have already racked up big returns have more flexibility.
When To Sell Stocks: A 2011 Case Study
MercadoLibre (MELI) broke out above a 27.52 buy point in a cup with handle on July 15, 2009, in heavy volume. The stock had a compelling story as the eBay of Latin America, an online marketplace for the region's increasingly wealthy population. Fundamentals on the day of the breakout were stellar — a 99 Composite Rating, a 91 EPS Rating and a 92 Relative Strength.
Most investors probably would have sold when the stock sliced through its 10-week line in huge volume on Jan. 11, 2010 (1). But those who truly liked the stock's long-term growth potential may have decided to wait until it breached the 40-week line in big volume. After all, they were still sitting on a profit of more than 50% despite the sharp slide.
The stock went on to form new bases and hit new highs, punctuated by sharp drops to support at the 40-week moving average (2). The stock peaked at 92.73 in the week ended April 29, 2011, representing a gain of 337%.
The final sell signal came during the week ended Aug. 5, 2011, when the stock finally plunged through the 40-week line in heavy volume (3). Those who sold would have locked in a gain of 258%. By October that year, shares fell as much as 48% below their 52-week peak of 92.73.
A version of this column was first published in the May 10, 2013, edition of IBD. Follow Chung on Twitter at both @SaitoChung and @IBD_DChung for more on growth stocks, chart analysis and stock market insight.
RELATED:
Time To Sell: When Your Stock Rebounds In Weak Trade After Big-Volume Sell-off
Do You Know How To Draw A Proper Trend Line To Capture Good Sell Signals?
