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An Nvidia Shakeout, And The Reason For CAN SLIM’s 5% Buy Zone

Learning new languages is tough. And learning how to invest and read stock charts, for most of us, certainly requires a new vocabulary.

A few terms often used by CAN SLIM investors are: extended, buy range and shakeout. All are related. Readers of Investor’s Business Daily and Investors.com typically see them on any day when stocks are climbing past buy points. An Nvidia (NVDA) breakout in the fall of 2017 emphasizes why the terms are important.

But first, a buy range or buy zone is a 5% area above a proper entry point. It is the zone in which investors can buy into or add to positions in stocks. The goal, whether the pattern is a base or a rebound off the 10-week moving average, is to buy as close to the actual buy point as possible.

More advanced investors will use the buy range as a rule when pyramiding into a position.

A stock within 5% of a buy point is said to be in its buy range. A stock that has moved more than 5% above an entry point is considered extended.

So, the big question, why 5%? After a breakout, many of the best leading stocks have a tendency to pull back and test buy points or their 10-week moving averages. Marking a 5% cutoff allows these pullbacks to occur without triggering the automatic sell rule: when a stock falls 7% or 8% below your entry price.

How To Invest In Stocks: Nvidia Teaches The Shakeout Lesson

That type of forced exit is called being “shaken out” of a stock. In short, buying within 5% of the buy point typically allows you to ride a normal post-breakout pullback, without being shaken out of the stock.

This is where chipmaker Nvidia comes in, with its breakout from a flat base on Sept. 15, 2017. The stock scorched past the 174.66 buy point in a five-week flat base, jumping more than 6% in huge trade.

ICnvda052118Despite the huge gain, the stock ended that day within the buy range that ran through 183.39 (5% above the 174.66 buy point). So, investors who missed that Friday breakout session could have come in on Monday and still bought. But only for a time.

Let’s say an investor waited too long, and jumped into Nvidia later on in that Monday session, at 185. That’s only 5.9% past the buy point. Hey, what’s the big diff?

Not Crossing The Line

The difference would become apparent as the stock declined over the next five sessions. An investor who bought Nvidia’s breakout at the highest possible price within the buy range — 183.39 — would have ridden a temporary pullback of 7.2%. Just short of the absolute kill-level decline of 8%, that would’ve avoided the golden rule of investing. He or she could ride out the test. At 185, the low of the pullback on Sept. 25 (1) would’ve been a shade over 8%. Shakeout time.

Another point: Nvidia remained in buy range over the next nine or 10 sessions (2), giving investors plenty of time to pile in.

By its peak of 292 in early October 2018, the stock gained as much as 67%, allowing plenty of chances to take profits on the way up.

A version of this column was originally published on May 18, 2018. Follow Alan Elliott on Twitter at @IBD_AElliott.

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