If you’ve traded top-performing winners among growth stocks long enough, you’ll likely get caught with a company that does what Nanometrics (NANO) did this past week.
It just took one valuation-driven downgrade Thursday by D.A. Davidson to send shares of the expert in semiconductor testing equipment to sink as much as 11% and force investors who bought at the cup base at the entry point of 44.27 to cut their losses at 7%-8% or less. The stock on Thursday had ranked No. 6 within the IBD 50, but no matter. On the bright side, Nanometrics shares appeared to get support near the 40 round-number level. Through Thursday, they also traded well above the 50-day moving average.
Still, such a slide hurts, especially when it makes up a considerable portion of the account. How can you minimize exposure to these all-of-a-sudden drops? Before you buy, examine the stock’s average turnover.
Is it thin? If yes, the more likely the stock will move sharply on the trades of just a few institutional money managers.
How To View Volume
IBD’s general rule is to stick with companies that trade a minimum 400,000 shares a day. Nanometrics comes up short in this measure, with average daily volume of less than 385,000. Yet another way to view volume? Calculate the average dollar-based turnover. Multiply the average share volume over the past 50 sessions by the current stock price.
It makes sense, then, to assume that on a day-to-day basis, that a top market leader that sees on average $200 million or $400 million worth of shares change hands each day is going to require a bunch of selling in order to move dramatically. Many mutual funds don’t even have those kind of assets, let alone that much money in a single position.
As of Thursday’s IBD 50 companies, the median average dollar turnover was $78 million. Nanometrics currently trades on average less than $15 million.
At least 11 companies, including Leaderboard member Lululemon (LULU), GrubHub (GRUB), Abiomed (ABMD) and Adobe Systems (ADBE), show an average dollar turnover of $200 million each day or more.
When looking at a weekly IBD or MarketSmith chart, keep in mind that the line drawn across the volume bars shows average turnover over the past 10 weeks. It’s similar to the 50-day average volume.
Of course, a stock with a relatively low dollar turnover can still trade in an orderly way after a fantastic breakout. And a heavily traded stock can certainly plummet on terrible news.
PGT Innovations Stock Survives A Scare
Consider PGT Innovations (PGTI). The stock trades on average $11.7 million a day — less than even Nanometrics. Yet the advance from a May 18 breakout past a proper buy point of 19.70 in a good flat base has been altogether quite smooth.
On June 14, the North Venice, Fla., maker of impact-resistance doors and windows sold off hard, falling 2%. At one point it dropped as much as 4.1% to a low of 19.70, kissing the recent buy point. But as the daily chart shows, PGT ended the session nicely in the upper half of the day’s range. It held on to a small post-breakout gain. Volume came in thin.
Nearly six weeks later, PGT gapped up and hit a high of 25.15. That pushed the profit from the breakout point to 27% — a great time to take at least some profits on the way up.
