When possible, in our personal accounts, managed accounts and nightly newsletter The Wagner Daily, we prefer to build a position in a stock that is forming a valid basing pattern, rather than immediately buying full share size at the obvious breakout level. For a quick primer on the type of basing patterns we trade click on the following link https://www.slideshare.net/morpheustrading/how-to-find-the-best-stocks-to-buy-before-they-breakout.
Many traders scale in to a trade, but scaling into a trade typically implies the stock is trading below its initial entry price and the trader is averaging down to achieve a lower average price. What we do is the opposite, as we start out with partial share size on a trade, but only add to the position as it moves in our favor.
An actual swing trade in Lumber Liquidators ($LL), which we entered back in Q1 of 2013, is a good example of how our system for building a stock position works. Check out the annotated daily chart of $LL below:
At the beginning of the year, $LL rallied above its downtrend line (pink line) and reclaimed support of its 50-day moving average. For us, this was a clear sign to begin closely monitoring the action for a potential low-risk buy entry point.
That low-risk entry arrived on January 8, on a pullback to the 50-day moving average, where we entered above the prior day’s high (above the line labeled “1” on the chart above). Although we could have added additional shares on the second pullback to the 20-day exponential moving average on January 16 (point “2”), we instead decided to lay low and wait for a potential breakout entry to emerge.
After a few days of tight price action on January 22 and 23, a low-risk breakout entry developed over the high of January 23 (point “3”).
Our actual buy entries for this swing trade were at points “1” and “3” on the chart above, but one could have bought at any or all 4 of the highlighted entry points.
Entry “4” was the obvious breakout entry point, from the handle portion of a cup and handle chart pattern. This is the level where many traders would have simply bought a full position (on the breakout above the high of the handle), but we preferred to already be holding at least a half position prior to the actual breakout.
By getting in a bit early, we are able to give the setup a bit more breathing room if the breakout at the handle fails, while still maintaining a low level of initial risk.
Sign up now to receive your real-time trade alerts, hot stock picks, and educational market analysis included with your Wagner Daily subscription.
As always, drop us a comment below to share your thoughts on this article.