Software stocks gave some clear buy signals a couple of weeks ago. But when ServiceNow and other leaders faltered, we were quick to exit and go more defensive. That helped lower the sting of Thursday's hit to growth.
After Basing Period, Software Stock Sets Up
Looking at the iShares Expanded Tech Software ETF to represent software stocks, showed a good looking setup. After a nice run starting with the Nov. 1 follow-through day, it looked like a favored area for the market rally. But starting in February, it started basing. It could be viewed as a double-bottom base and we used the middle of the "W" as a potential buy point for the ETF (1).
Once IGV got near that entry (2), it started to tighten up for the next few days. When it popped above 85.22 on June 27, we added it to SwingTrader (3). The improved relative strength line after its monthslong base was an extra clue that software stocks were an area of interest.
We added to the position on June 28 before the market saw a big downside reversal (4). But IGV again showed the relative strength of software stocks. It remained positive while most leading stocks saw an ugly reversal.
Adding To What's Working
As the market quickly recovered from its downside reversal, IGV cleared its June 28 high before the indexes did (5). That was worth another add to the position and brought it to a full position (currently targeted at 10% for SwingTrader). We decided to make it a little more than full a few days later as it surpassed its all-time highs from February (6).
Technical Analysis: The importance of downside reversals
Two important points on how we added to software stocks on the way up. First, our reliance on strength as opposed to weakness. We average up, we never add to a losing position by averaging down. This lets the market give us feedback that what we are doing is working. And buying right will solve a lot of your selling issues.
Second, even though we were buying near the highs, because we started early our average cost was still less than 1% from our original entry. The original entry for IGV was 86.53 and our average cost, after all the adds, was just 87.30.
ServiceNow Stock Delivers Shot Across The Bow
Even though we followed sound strategy principles, the market has a way of throwing curveballs. On July 8, a day after clearing new highs, a downgrade for ServiceNow shook up a lot of software stocks (7). We had a position in ServiceNow that we exited but IGV remained an inside day and so we gave it an extra day.
Things got worse. The next day, we sold the bulk of the IGV position as it kept going lower and couldn't find support (8). A small number of shares made it until the next day but then were sold on further weakness.
Losing trades will happen. It's impossible to eliminate them completely. What you can do is minimize the damage.
Don't drive average costs up too much so that you can weather storms. When weakness happens, there are often early signals. Take cues from the proverbial "canaries in the coal mine" that can suggest a position might get in trouble and don't hesitate. Software stocks are most likely not done for this rally, but we can wait for another entry before we try them again.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
