When to buy growth stocks the right way? Think about the moment you drink a cup of fresh brewed hot coffee. You can avoid getting burned badly by taking sips instead of just gulping it down.
Take a similar approach with hot growth stocks. If you find a stock with top-notch fundamentals and technicals, don't jump in all at once. Start by using a portion of your allotted capital for the trade. Then build up into a full position as the stock rises. IBD calls this process "pyramiding" into a position. It helps reduce risk.
Investors can use all of their allocated capital and buy their entire position at one time. But just be aware that while you can make more money this way, you can also quickly lose more money by going all-in.
For example, if you use $10,000 to buy 200 shares of a $50 stock, all of your initial investment is at risk. If the stock falls 8% and you adhere to the golden rule of investing, you'd lose $800. If you started with half of a $10,000 position, or $5,000, you'd lose less if you were forced to cut losses at 8%.
Pyramiding involves making multiple purchases to build your position. You can divide your purchases into three installments.
When To Buy Growth Stocks: The Art Of The Pyramid Purchase
For your first buy, use half of your maximum capital that you would allocate for a single stock investment. So if you have $10,000 to invest, use $5,000 for your initial position. Start things off right by buying a leader once it goes through the proper buy point of a good base in volume that's at least 40% above average.
Only buy more shares if the stock moves 2% to 2.5% above your initial purchase price. If it does, use 30% of your allotted capital for your second buy. Now you're 80% invested. If the stock goes up another 2% to 2.5% from your second buy point, use the remaining 20% of your allocated capital for your final buy. Now you're fully invested and the stock is acting right.
Pyramiding is smarter, as you're putting more money to work only after a stock has proven that it can go higher. What you are essentially doing is averaging up, the opposite of average down. The latter is often a losing proposition.
When To Buy Growth Stocks: Starbucks And Toasty Gains
On Oct. 12, 2010, more than a year after the March 2009 market bottom, Starbucks bolted past a 26.67 entry from a cup with handle in about twice its average trade (1). An initial position that made up 50% of your designated full stake could have been put on there.
You could have established a second buy on Oct. 12 — the same day as the breakout — or in the next few trading sessions as shares rose more than 2% past the proper entry point. The final buy? On Oct. 14 as Starbucks rallied 4% past the 26.67 buy point (2), near 27.74.
The stock rose 25% by early January 2011, issuing an offense-style sell signal, before pulling back to its 50-day moving average.
In November 2018, Starbucks joined IBD Leaderboard as an emerging new market leader.
A More Recent Example
Shake Shack. The stock sprinted up to a peak of 96.75 in just 16 weeks after its NYSE debut in January 2015 at 21 a share. It then melted into a long, deep correction lasting years.
But 2018 cooked up a different story. The premium hamburger and shake chain cleared an excellent 17-week cup with handle on April 26. The stock rallied 2.15, or 5%, to 45.40. Volume edged 13% above its 50-day average. The buy point was 44.50, a dime above the highest price within the handle.
Let's say you wanted to invest $50,000 in Shake Shack. You could buy roughly $25,000 worth, or 560 shares, as soon as they hit a price of 44.50. Once the stock rallied 2.5% above the 44.50 correct buy point, or 45.61, then you could add another 330 shares the next day, on April 27. Shake Shack bolted 1.85 points, or 4.1%, and got as high as 47.50 intraday, a new 52-week peak. Volume jumped 69% vs. usual levels.
Your total stake now: 890 shares, $39,971.30 deployed, average cost of $44.91 a share. The session on April 27 proved so strong that you could have completed the full position with the third buy of 215 shares at 46.73 apiece ($10,046.95).
Shake Shack Buys: 3 Layers Of Goodness
Just five sessions later, the stock rocketed up 18% and hit new multiyear highs following strong Q1 results (adjusted earnings per share up 50%, sales up 29% to a record $99.1 million). By late June, Shake Shack nearly hit 70, up more than 50% from the correct buy point of 44.50.
A version of this article was published on Jan. 24, 2012. Please Chung on Twitter at both @SaitoChung and at @IBD_DChung for more on buy points, sell signals, growth stocks and financial markets.
RELATED:
Current Top Growth Stocks In IBD Leaderboard: Check Here
Still The Golden Rule Of Investing
The Next Most Important Sell Rule After The Golden Rule Of Investing
