Imagine you've located the perfect stock.
Although timing into the market isn't as important for long holding periods as it is for short-term trading, investors with an eye on the long term can improve results by implementing the trade entry methods of short-term active traders.
The difference is that instead of using minute to hour price timeframes for decision making, the long-term investor will use day or week price timeframes in an attempt to nail the perfect entry level. The perfect entry level is one from which the price barely pulls back, if at all, before taking off on the upside.
There are two schools of thought when it comes to purchasing a stock: momentum and pullback.
Momentum investing is when one waits for the share price to break out above a level before buying. The theory behind momentum investing is that the underlying pressure lifting the share price will continue after you enter the trade. Momentum investing works best on stocks that are heavily in the news and when a pending catalyst is believed to have a bullish effect. Here's an example of a stock that made for a good momentum entry.
Although I incorporate momentum investing into my stock toolbox, my preference is for pullback investing. Pullback investing is when you wait for the stock price to drop to a major support level or wait for the first signals that indicate the selling is ending and a bounce has started. I prefer the pullback investing method over the momentum idea for the following reasons:
1. The stock offers discounted value: Having fallen off its highs, stocks in the pullback phase provide the investor a chance to purchase at a discounted price.
2. Buy when others are selling: The best time to enter a stock is when others are selling it. Stocks are sold for many reasons and a primary one is to take profits. This has nothing to do with the quality of the company or its potential. It's simply a market fact that provides the opportunity for savvy investors to buy quality names at a discounted price.
3. It's how the pros do it: Most professional investors and funds wait for pullbacks to purchase stocks. Only in rare circumstances will a professional investor or investment fund buy shares at new highs. Waiting for a pullback puts you on the same side as seasoned investment professionals.
I regularly screen the market for pullback trading opportunities, and I recently found a powerful one. I would never buy a stock on the technical picture alone, but when other bullish factors combine with a technical setup, it can paint a compelling picture. The technical pullback setup is in none other than Dow Jones Industrial Average component McDonald's (NYSE: MCD).
Let's first take a look at the technical picture. The stock price has fallen and has found support at the 200-day simple moving average. The 200-day simple moving average is considered by technical analysts to be the ultimate support level for stocks. Provided the huge attention paid to this Dow component by index funds, hedge funds, exchange-traded funds (ETFs) and other professional investors, the 200-day moving average becomes even more critical as support.
|McDonald's is now testing lobster rolls as part of the menu in certain markets.
The company reported sluggish results during the second quarter, resulting in the stock sinking to technical support. However, the 58-year-old company is undergoing an extensive remodeling effort to make its restaurants friendlier and a popular hangout destination.
In my recent article on Dunkin' Brands (Nasdaq: DNKN), I referred to these types of changes as the Starbucks (Nasdaq: SBUX) effect. Not only is McDonald's rehabbing the look and feel of its stores, but the company is adding fresh new products. For example, McDonald's is now testing lobster rolls as part of the menu in certain markets. Yes, lobster at McDonald's! This would have been inconceivable just a few years ago.
Boasting a tremendous market cap of more than $94 billion and offering a forward annual dividend yield of 3.2%, the company is well positioned to weather the temporary lackluster quarter. In addition, nearly 65% of shares are held by institutions, which points to the internal strengths of the company.
Risks to Consider: As the biggest player in the fast-food industry, McDonald's is constantly under attack by other major burger chains, as well as smaller upstarts. In addition, market risk is high with the Dow's sensitivity to the overall economy. Always use stop-loss orders and position size properly when investing.
Action to Take --> I like MCD right now with a stop-loss below $90 and a 12-month target of $101. The technical pullback, combined with the menu and restaurant improvement, should work over the long run to get the stock back on track.