Why Traders Should Buy One Of Today’s Biggest Losers

Peter Lynch, the legendary portfolio manager of the Fidelity Magellan fund until his retirement in 1990, said that investors can find great stocks by simply walking around the local shopping mall. Wherever there are crowds lined up to buy from a company, chances are its stock is a good investment. 

Based on this theory, my own reconnaissance tells me that shares of Dunkin’ Brands (NASDAQ: DNKN) will soon be back in rally mode.

#-ad_banner-#After a solid 2013, the stock peaked in March of this year. It’s been a rough road since then, culminating in a 7.3% drop at the open on July 24, after the company reported a shortfall in second-quarter sales. 

Technically, we can call it a selling climax or capitulation based on the large price movement and huge volume. With the supply of shares finally dried up, the stock started to come back. The trend since then has actually been to the upside, albeit with many bumps along the way.

Fast forward to Thursday when the company again reported lower-than-expected sales for the third quarter despite beating earnings estimates. Once again, the stock cratered on the open, this time by 5.5%, only to be followed by buyers swarming in to cut the stock’s losses. Although DNKN then returned to its lows later in the day as the entire market weakened on news that there was a possible Ebola case in New York City, it still closed above support on the charts.

DNKN Stock Chart

The $43.40 level provided support several times before the July washout and several times since. Indeed, we can trace it back to last year when prices hovered around it for several summer months. So it should not have been a surprise when buyers once again stepped up Thursday as prices neared this level. 

There is still work to do to break free from a six-month trading range, but there are reasons to believe that it will happen. 

The first is the upward curve of the 50-day moving average. As we can see in the chart, enough time has passed since the price slide earlier this year to allow the stock to repair that damage. With prices spending more time above the average than below, the math demands that the average starts to rise. 

It is not a good idea to use the 50-day average as a hard support or resistance feature, especially when its slope is rather flat. But because it is a proxy for the short-term trend, the fact that it is curving back up is a positive development. It may not look that way, but the trend bias is actually to the upside.

DNKN has failed twice at its 200-day average in the past two months, and it is still officially in a trading range loosely bounded on top at $47.50. But it is the stock’s resilience in the face of bad news that is important. 

While the company warned that it may have trouble reaching its sales targets for the year, buyers still came in Thursday, even if only temporarily. It is this sentiment — the positive reaction to bad news — that piqued my interest. And it happened not once but two separate times after earnings were released. 

Add the trading action of its peers to the mix — even the long-beleaguered Krispy Kreme Doughnuts (NYSE: KKD) has been rallying since July — and there is a positive story to tell behind simple chart analysis. 

Recommended Trade Setup:

— Buy DNKN at the market price
— Set stop-loss at $42.75
— Set initial price target at $50 for a potential 14% gain in three weeks

My colleague Amber Hestla has also recognized the importance of not getting caught up in the day-to-day results. It’s not “dumb luck” that every closed trade is a winner — 52 trades, 52 winners in the past 12 months. Amber’s strategy works. You won’t want to miss her next recommendation.

This article originally appeared on ProfitableTrading.com: Why Traders Should Go Long One of the Day’s Biggest Losers