How to identify hot stocks that have more to give

The S&P 500 recovered last week from earlier October losses, but remains below its 52-week high. While the bulk of stocks are in a similar position, there’s a smaller contingent of stocks which continue to perform well, reaching new 52-week highs. This is bullish for these stocks, but buying at a new high isn’t always the wisest trade, especially given the price action of these stocks.

The Kroger Co. (above chart) has been in a resilient upward trend channel going back to March. Because of the tight channel buying on new highs usually means the price attained is right near the top of the channel. To make a profit on such a position the trader needs to hold through a pullback to the bottom of the channel and then wait for the stock to rally back to the top, reaping a small gain for the effort. Instead, wait for a pullback to the channel bottom. Then wait for a small consolidation along the channel bottom; an upside breakout of that consolidation signals a buy. A bullish engulfing pattern which occurs along the channel bottom also provides a potential entry signal. Look to exit near the top of the channel, with a stop below the recent low which formed just prior to entry.



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The trend channel in Diamondrock Hospitality Co. extends back to February, and the stock hit the top of the channel and a new 52-week high on Oct. 23. While the price could always break above the channel and continue running to the upside, the prudent play right now is waiting for a pullback to the channel bottom near $13 to $12.75. Watch for a consolidation and an upside breakout or a bullish engulfing pattern along the channel bottom.
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UnitedHealth Group Inc. continues to perform strongly, in line with the broader health-care sector. On Oct. 24 the stock made a new 52-week high and also touched the top of its trend channel which extends back to the start of the year. The very strong rally may tempt traders into buying at the top of the channel, yet this likely isn’t the most efficient use of capital. Short term traders should consider taking profits in the $91 to $92 region – or whenever upward momentum halts – as the multi-month tendency is for the stock to retreat toward the channel bottom. The next buying opportunity comes near the channel bottom at $85 (projected based on upward angle of channel), using the methods discussed prior.
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Costco Wholesale Corp. had big moves recently, overshooting the top of its seven-month trend channel twice in October. Costco did put in a new high on Oct. 22, a good sign, but the drawback is that it looks like it could be a double top. Combine the potential double top occurring at the top of the channel and buying near $130 isn’t the highest-odds trade. Despite the warning signs, this stock remains in an uptrend, so buying near projected support of $125 (based on channel bottom) using prior mentioned methods is still the play. The double top pattern isn’t complete until the price drops below $122.05 (October low); until that time, use the channel for general entry areas and profit targets.




 
Look at tendencies within stocks. In the case of these stocks, they’re performing well but have been moving in a channeling fashion for the better part of a year. Consider that when determining when to enter a strong stock. The compulsion is to buy as its surging to new highs in order not miss any more of the move. By looking to buy near the low end of the channel, risk is reduced because a stop loss can be placed closer to the entry price, the tendency of the stock movement is in your favor and a general profit target area is easily estimated based on the established channel. Losing trades are inevitable, and these channels will eventually break. Limit risk on any single trade to one per cent or less of account capital.

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