Early October’s sharp sell-off in the stock market pummeled leading growth stocks. Many top stocks triggered sell signals after strong breakouts above buy points. The weak action was enough to shift the market into a correction, according to the IBD Big Picture.
Now that the stock market is in a correction, new buys are not advised. Instead, investors should monitor the top stock ideas and wait for a follow-through rally confirmation. (That’s basically a big one-day rise in a major index in higher volume at least four days from an index low.) Not all follow-throughs work, so it’s important to remain disciplined and patient even after the signal occurs.
Keep in mind that leading stocks of the past may not be the leaders of the future. To help pinpoint stock leaders that emerge in a new market uptrend, use the relative strength line to see which stocks are outperforming the general market.
The RS line helped identify Fortinet (FTNT), Palo Alto Networks (PANW) and Square (SQ) as potential leaders before their recent gains.
Focus On A Stock’s Relative Strength
The relative strength line is a key technical metric to help investors find leading stocks. The RS line is painted in blue ink on every IBD daily and weekly chart. It measures a stock’s price performance relative to the general market, specifically the S&P 500. It trends upward when the stock is outperforming the market and vice versa.
During a stock market correction, investors should identify companies whose stock prices are fighting the stock market downtrend. A strong RS line will be pointing sharply higher, either during the basing period or soon after a breakout.
These 3 Stock Leaders Took Off This Year
The cybersecurity industry has been one of the top groups in 2018. It is currently ranked in the top 35 out of 197 groups. The leading stocks within the group — Fortinet and Palo Alto Networks — went on to solid advances after the stock market sell-off in early February.
During the stock market’s extreme volatility in February, Fortinet merely pulled back to its 50-day line before quickly rebounding. The test of the 50-day line was the second pullback to the support level after a breakout from a double bottom base, and marked a follow-on entry. The RS line hit a new high Feb. 6 when the stock leapt 6% on strong earnings.
At its Oct. 1 peak price of 94.37, the stock gained as much as 102% from the Feb. 6 closing price of 46.54. Now, Fortinet is below the 50-day line, as it threatens to end that long advance.
Palo Alto Networks broke out above a 156.95 cup-shaped base entry on Jan. 18, but the RS line had not made a new high (1). Shares failed to gain traction until they pulled back to their 50-day line. After finding support on Feb. 9, the stock went on an eight-day winning streak. Significantly, the RS line hit new highs during that time (2). Palo Alto shares continued to climb for months.
Palo Alto’s stock looked to add to its gain when it broke out past a flat base on Aug. 24. But the move rapidly faltered. During the current market correction, the stock triggered a sell signal when it fell more than 7% below the 219.48 entry, according to MarketSmith chart analysis.
Another weak market environment from March to May created Square’s double bottom during that time frame. Shares for the payments processing firm broke out May 8 above the 52.60 buy point. On that day, the stock’s RS line didn’t confirm the stock’s strength. Several weeks later, the stock added a handle with a 57.29 buy point. When the stock broke out on May 29, the RS line was much stronger. At its 101.15 peak, Square advanced 92% from the double bottom’s 52.60 entry.
Square sold off below its 50-day moving average line on Oct. 10 in huge volume, triggering a key defensive sell signal.