Time the Purchase and Sale of Stock

Timing the purchase and subsequent sale of stock will increase portfolio yield. This will require a certain amount of patience and skill. One must view the current price per share in context with historical data and future estimates. Analytical tools must be used to determine when to buy, sell or hold stock. To reduce mistakes and increase yield, analytically examine each investment carefully. 

When should I buy a particular stock?

All right, you found a well-managed company that is doubling in share price every 1.25 years and you just have to have it. Share price of most stocks fluctuate wildly from day-to-day, week-to-week, and month-to-month. How do we know if the stock is overpriced or under priced?    

There are several ways to decide whether a share price is in the “buy zone.” The buy zone is a price range that you feel comfortable purchasing shares at. The buy zone is not the same for every investor. You define the buy zone based on your investing strategy. There are several buy zone-defining strategies you should consider.

Historical P/E versus current P/E

Consider purchasing shares when the current P/E is below or at the historical P/E. For example, if the current Trailing Twelve Month P/E (TTM P/E) is 34 and the historical P/E is 40, the current share price would be in the buy zone. Conversely, if the current TTM P/E is 45, the stock is not in the buy zone. The TTM P/E is easily calculated and obtained online at any financial website as a part of a stock quote. However, historical P/E data must be obtained from the Ratings and Reports section of Value Line.

High and low share price plots

Use the historical high and low share price plots on the growth graphs to determine a buy zone. Consider the growth graph of Advent Software, see next page. Use the annual share price highs and low regression lines to predict what the high and low share price will be in the future. For example, let’s say it is 2001.5 (June 2001) and you want to determine what the high and low share price would be based on the historical data.

Simply follow the vertical line up from 2001.5 on the x-axis until it intersects the low share price line (open diamonds). Now follow the horizontal line over to the left-hand y-axis to determine low share price. Repeat the process to determine the high price. In this case in 2001.5 the high share price is predicted to be $110 and the low price is predicted to be $60. Consider defining a buy zone that is below the midpoint between the two numbers, i.e., anything below $85.

Use charts of share price and moving averages to locate entry points

Another method used to determine when to buy stocks utilizes charts that plot daily share price and its moving average. What is a share price moving average? Good question.

Analysts calculate share price moving averages by defining a time frame such as 5 days, 10 days, 20 days, 50 days, 200 days, and the like. They estimate an average by going back the defined period of days and adding up the closing price during the defined period. For example: a 5-day moving average would be calculated by adding the closing prices for the last 5 days and dividing the total by 5.

            day 1    day 2    day 3    day 4    day 5

            (10 +    11 +     12 +     13 +     14) = 60

                                    60/5 = 12 (moving average on day 5)

A moving average is termed as such because as the newest period is added, the oldest period is dropped. If the next closing daily price is 15, then this new period would be added and the oldest day (10) is dropped. The new five-day moving average would be calculated as follows:

           day1     day 2    day 3    day 4    day 5    day 6

            10        (11 +    12 +     13 +     14 +     15) = 65

                                    65/5 = 13 (moving average on day 6)

Notice how the brackets defining the five-day period shifted by one day. That is why they refer to this averaging technique as “moving.” Move those brackets down the line mister. Over the last two days, the moving average changed from 12 to 13. A share price chart with both 50-day and 200-day moving averages is given below.

Notice how volatile the daily price is relative to the 50-day or the 200-day moving average. Moving averages smooth the daily price data. The longer the moving average the smoother the data. Hence, the 200-day moving average plot is smoother than the 50-day plot. How is this graph interpreted?

An entry point forms when the shorter of the two moving averages crosses above the longer moving average. In this example, a entry point forms when the 50-day moving average crosses above the 200-day moving average at points A, B, and C. The 50-day and 200-day time periods are used to decrease the volatile daily price and clearly establish long-term trends. Shorter moving averages are for short-term trading strategies not long-term investing. However, locating an entry point every month with 200-day and 50-day moving averages might not be possible. For example, if all of the growth companies you are tracking do not reveal an entry point with 200-day and 50-day moving averages, reduce the moving averages to 50-day and 10-day. DCA requires consistent monthly investments. Do not delay a monthly investment if the 200-day and 50-day moving averages do not point out an entry point. Shortening the moving averages will increase the probability of locating an entry point. Where can I create these graphs?

Fortunately, graphs of various moving averages and current share price are easily obtained online. Start at Ask Research, www.askresearch.com. Click the daily chart tab, choose 60-month time span, and select the two moving averages you would like to see on the graph (consider 50-day and 200-day). Type in the ticker symbol of the stock you are studying and click on the create chart button. Voila, your 5-year chart appears. Use these graphs to locate entry points.