Several months ago, our trading system enabled us to buy a strong breakout stock when it pulled back to its 50-day moving average, which we subsequently sold into a rally for an average gain of 26.8%…and I’m going to show you exactly how we did it.
In this article, we walk you through that trade to show the technical rationale for buying shares of Fabrinet ($FN) when we did, as well as the timing and methodology for taking profits into strength of the monster advance that followed.
Relax, grab a drink and your notebook, then continue reading to learn how this trading strategy can be applied to your next breakout stock.
The Setup
NOTE: The commentary in italics and first two charts below originally appeared for subscribers in the March 15 issue of The Wagner Daily:
We have one new setup on today’s watchlist in $FN, which cleared an 18-month long trading range late last year.
$FN monthly chart:
Six weeks ago, $FN gapped above $23, breaking out from a three-month long base on big volume.
[Next, let’s zoom into the shorter-term WEEKLY chart below:]
Last week’s reversal bar off the rising [similar to 50-day moving average] on a pick up in volume was a bullish sign.
We are placing a buy limit order, looking for an entry on very short-term weakness [pullback to 10-day moving average on daily chart].
The stop is placed below last week’s reversal candle, minus some wiggle room (not much though).
The Entry
Our exact buy limit price listed in the newsletter on March 15 was $27.40, and the following annotated chart shows our pullback entry into Fabrinet stock that same day.
Also of importance on the chart below, note the strong rally that occurred on March 11, just three days after $FN bounced off key support of its 50-day moving average (teal line).
Increasing volume confirmed that day’s 5.3% advance as well.
Such price action is bullish, and is indicative of how healthy stocks should act after retracing to their 50-day moving averages.
Take a look on the daily chart:
Notice how the March 15 buy entry was on a pullback of the March 11 rally, which neatly aligned with horizontal price support from the low of the big “gap up” in early February (pink horizontal line).
We expected this pivotal area of support in the $27 to $27.50 area to hold up, which provided us with a low-risk buy entry on the pullback.
But even if that level of support failed, we knew that major support of the 50-day moving average was hanging out below (around $26.40), and we were prepared to patiently hold the position if that occurred.
The 20% Gain
The $27.40 entry worked out well, as $FN worked its way higher over the next two weeks, highlighted by a 13% advance in three sessions from March 24 to March 29.
By the close of March 29, the price had extended far above the 20-day exponential moving average and was 20% above our entry price.
To lock in some profits in case of a pullback, we alerted subscribers that we were selling 1/4 of the position on the next day’s open.
This is shown on the daily chart below:
For short-term swing traders, selling the full position for a 20% gain that day (March 30) would have been fine as well.
However, in stocks with strong earnings and revenue growth (like $FN), we do not mind holding at least half a position in anticipation of larger gains.
The 29% Gain
Over the next few weeks, $FN consolidated while holding short-term support of its 20-day exponential moving average.
This bullish price action gave us a large enough profit buffer to be comfortable holding the remaining 3/4 position size through the next quarterly earnings report.
After reporting earnings on May 2, $FN jumped 14% higher to close near $36.
But this time, we placed a tight protective stop at $35.36 to lock in gains on the rest of the shares, rather than sitting through a potential pullback.
The stop triggered the following day, enabling us to score a sweet 29% gain on the final 3/4 position (26.8% average gain on the entire trade).
The Takeaway
When a stock with strong earnings and revenue growth gaps sharply higher (as $FN did in early February), waiting for the price to consolidate and meet or pullback to the 50-day moving average provides an ideal buy entry point to catch the next rally higher.
Patience to wait for the proper timing is crucial; make the stock come to you, rather than chasing it.
Then, tighten your stops to lock in gains when the stock subsequently catches fire again.
Of course, always have a predetermined initial stop in place, just in case the price action fails to follow through as planned.
Also, in case you are wondering why $FN made our watchlist in the first place, check out this excellent mini-lesson that explains how to find the best stocks to buy before they breakout.
Finally, Top 5 Qualities Of The Best Stock Breakouts is a fantastic educational article that clearly explains how we find profitable swing trade setups in our daily stock pick service.
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