Banking

Why Not Every Break Of Support Is A Sell Signal

When Apple (AAPL) fell below its 50-day moving average in October, was it a sell signal?




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The character of the personal electronics company certainly changed for the worse. Shares slid as much as 22% below prior highs. What appeared to be a handle forming became just another leg down in a price correction.

Despite the sudden wave of selling, most stories at Investors.com did not call it a sell signal. Why?

A break of this important moving average is significant, to be sure. It tells investors that institutional investors are not buying shares at dips they normally would find attractive. In fact, winning stocks tend to stay above the 50-day (or the 10-week moving average on a weekly chart) for their entire run, finding support at least a few times.

But you can’t consider it a sell signal every time a stock falls below its 50-day or 10-week line. The intensity of volume, the severity of the price drop, and the stock’s relationship to the line during its advance are factors used to decide if a sell signal has occurred.

Only one sell rule involving the 50-day line  is mentioned in “How to Make Money in Stocks,” the investment classic by IBD chairman and founder William O’Neil: Sell when a stock starts living below the 50-day or 10-week line. By “living” take that to mean at least eight straight weeks trading below the line.

The 50-day line itself may begin to flatten out while the stock takes up residence underneath it. This shows the stock is losing momentum.

IBD’s Chart School, formerly a live seminar that is now a home study course, expands on the sell rules related to breaks of support. Here are three points:

  • Breaking below the line in heavy volume is a bad sign (and probably a sell situation), especially if it’s the first such break following a long price advance.
  • Falling below the line after a stock has found support repeatedly at the 50-day average also is a bad sign.
  • Often, a stock will undercut the line slightly for one to three days, then rebound. This is a head fake investors have to watch out for.

In 2015, Palo Alto Networks (PANW) peaked after a powerful advance from a base-on-base breakout in September 2014. The network security company roared more than 130% to a peak in July 2015. The sell signal came a few weeks later, when the chart traced the classic signal.

Palo Alto pierced the 10-week line in heavy volume (1) during the week ended Aug. 7 after the line had protected the advance more than a half-dozen times. The stock failed to rebound significantly and has never regained the winning form it had up to that point.

What about Apple? The stock did recover back above the 50-day line and continues to work on a new base.

This article originally was published July 7, 2017. Juan Carlos Arancibia is the Markets Editor of IBD and oversees our market coverage. Follow him at @IBD_jarancibia

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