One of the stock market's paradoxes is that what seems too high goes higher and what seems too low goes lower. But there's a limit. Nothing goes up forever — even the best growth stocks.
Every experienced stock investor knows that at some point, what seems too high in price is in fact too high. So how do you objectively measure how high is too high?
One way is to calculate the distance from the 200-day moving average to the stock's current price on a daily chart. If the price is more than 70% to 100% above that level, maybe it's time to think about selling.
The 200-day moving average tracks a stock's average closing price over the most recent 200 days of trading. After another session on Wall Street ends, a new average price over the latest 200 days gets calculated. That's why the average is a moving average.
(You can see the 200-day line drawn in black on every daily chart in MarketSurge, IBD's elite-level charting and stock screening service. On the weekly chart, the 40-week moving average acts in similar fashion as the 200-day line on the daily chart.)
IBD founder and longtime former chair William O'Neil lists that as a sell signal in his book, "How to Make Money in Stocks," but admits he rarely uses it.
So maybe it's best just to think about selling. Use charts to spot poor action and wait for a second proper signal, such as a terrible drop through the 50-day moving average in huge volume, before pushing the sell button.
Why The 21-Day Exponential Moving Average Matters
When To Sell Growth Stocks: Defying Gravity For A While
Take the example of former highflier Emulex during the spectacular bull market that began in August 1982.
The computing networking company was a screaming winner after breaking out of a base in late August that year (1).
After a one-week respite, it ran up nine straight weeks (2), a sign of strength that should have encouraged an investor to hold on for the longer term.
It made its entire run without dipping below its 10-week line, and only sought support there over one short period about midway through its run.
The week ended March 25, 1983, was a big one for Emulex. It shot up 33% that week (3). The stock was now 149% above its 200-day average (as seen on a daily chart) and 140% from 40-week line on a weekly chart. The stock also rose or refused to lose ground for 11 straight days.
One definition of a climax top is that, after a long advance, a stock runs up seven of eight days or eight of 10 days. When that happens, it's time to sell. If an investor was lucky enough to sell right at the top, he could have locked in a 323% profit in seven months.
The Peak
Even then, Emulex (now part of Broadcom) was one of those rare screamers among top growth stocks that wasn't quite done. After a two-week rest, it rose again, closing out the final week of its run, the week ended June 10, with a 111% leap above its 40-week line while running up for 10 straight days (4).
Emulex demonstrates the importance of proper selling using a daily chart. Emulex would not see that high again until 1995, more than 12 years after its June 1983 peak.
A version of this column was first published in the Oct. 31, 2013, edition of IBD. Emulex was acquired by Avago Technologies, now known as Broadcom, in May 2015.
Follow Chung on X/Twitter: @saitochung and @IBD_DChung
