As Darvas traders, we’re essentially trend traders. We identify a hot stock, buy it when it breaks out of a base, and hold it for as long as it continues in a strong upward trend (or vice versa in a downtrending market).
There are two main reasons to sell a stock that has been trending higher.
1) It falls through a support level we’ve identified within the upward trend. Thus, the stock breaks its trend.
2) It flashes warning signs that tell us it is no longer a market leader.
Reason No. 2 can be very difficult to implement.
In the vast majority of cases, I’d prefer to follow Reason No. 1 and wait until a trend is clearly broken to sell. However, there are times when your own judgment must be used and you have to “read” the warning signs a stock is showing.
One such warning sign is underperformance in a strong market environment.
Just as market pullbacks often separate the real leaders from the weaker hopefuls, so too do market surges.
When the market aggressively moves higher and several leading stocks break out and hit new highs on strong volume, it raises big red flags for those stocks that FAIL their breakout attempts.
Likewise, when the market surges higher on increased volume, it raises red flags when we notice certain stocks drifting sideways in low volume. It makes us ask the question, if the market is in such a buying frenzy, why isn’t the market buying THIS stock?
This type of action by itself is usually not a good reason to sell. However, if we see this type of action AND notice that fundamental growth expectations are being lowered; it’s almost always time to sell.
A good example of this behavior occurred last week with SAM.
Take a look at the chart that accompanies this article. You’ll recall that last week the market surged on higher volume and several leaders broke out into new-high territory on outstanding volume.
But notice SAM’s action during this time. It drifts LOWER on unimpressive volume, completely left behind by the market.
It wasn’t that SAM was acting all that badly. In most market environments, this type of downward drifting on decreased volume would be seen as constructive consolidation.
The problem was that SAM was underperforming during an aggressive market upsurge, which is not the sign of a market leader. (It also didn’t help SAM’s case that, from a fundamental standpoint, sales figures were falling below our Darvas requirements.)
What was particularly troubling about SAM last week was that its Relative Strength was declining during very bullish conditions, which means that the stock was performing poorly compared to the rest of the general market.
True market leaders will see their Relative Strength increase when the market catches fire. When SAM failed to do so, I advised in Darvas Trader PRO that the stock should be exited in order to concentrate on the true market leaders that were emerging.
As the week went on, SAM dropped to $88.01, which would have hit our support-based stops (placed below the intraday low set on SAM’s recent gap-up day). In other words, by exiting SAM based on the sell signals the stock was flashing, we saved ourselves from a loss of roughly 7%.
The point of this example is not to pick on SAM. (Hey, I love their beer!) The point is to realize that stocks will often tell us it’s time to exit BEFORE it becomes obvious to everyone else, such as breaking a noticeable support level.