Tickers in this Article: DRI, SONC, EAT, AFCE
The stock markets cleared some resistance levels Monday after a gap higher followed by a strong close. While the move may end up following through higher, it did come after three prior up days. This means that many stocks are already several days into a move, and thus are not presenting good short-term risk/reward opportunities. In situations where I feel the markets may have more upside but could use some sideways trading, I like to focus on stocks that are still close to support. Restaurant stocks are one group with many stocks still in a decent position. Darden Restaurants (NYSE:DRI), for instance, is above its base. This is a sign of strength, but the stock is not too extended to be considered for a trading setup. One of the most important factors for a trader to consider is how much risk a trade involves and the likelihood of a move against the trader's position. The more extended a stock is from a safe buying point, the more likely the trader will have to endure a drawdown, even during healthy market movement. The problem is that a trader won't know if the movement is healthy or not until an important level is broken. If a stock is extended, that level may be so far away that a trader will have to risk too much in order to get an equal return to the upside. DRI appears to be pulling back toward the $50 level, and could present a good opportunity if buyers step in.


Source: StockCharts.com
Sonic (NasdaqGS:SONC) is revealing a different pattern, although it is still a decent choice for the current market. SONC has formed a cup and handle pattern throughout 2011. In the early part of the year, this stock was in a decline, before rounding out in March and April. In late April, it experienced a sharp rally forming the right side of the base, and has been flagging since then in a tight range between $11 and $11.85. A break above the handle would confirm the pattern, and offer a decent entry into this stock.

Source: StockCharts.com
Brinker International (NYSE:EAT) is another restaurant stock in a decent position. EAT has been forming a base for most of 2011 and is just starting to poke its head above the $26 level. This level has been stopping all rally attempts, so a move above it could be a sign of a breakout. (For more, see The Anatomy Of Trading Breakouts.)

Source: StockCharts.com
AFC Enterprises (NasdaqGS:AFCE) is an example of a restaurant stock in a healthy pattern, but it is likely a too extended for a safe entry. AFCE cleared a base it had been holding for several months yesterday by breaking above the $16 level. While this is a strong signal, it also follows three prior strong days. This first area to look for support would be under $14.50, which is where the move started. This puts the risk at more than $2 away from the current price. The best course of action will be to wait for AFCE to consolidate near $16 for a few days. If this plays out, it could offer an entry to a continuation move higher. (For more, see Support And Resistance Zones.)

Source: StockCharts.com
The Bottom Line
It's often easy for traders to get carried away during a market bounce, especially if they feel like they are missing the move. However, controlling your risk is priority No.1, and if the market is truly ready to resume moving higher, it will likely offer plenty of chances to get long. By sticking to stocks close to support, traders can protect themselves and avoid becoming too exposed to what could end up being a normal retracement. (For more, see Sinking Your Teeth Into Restaurant Stocks.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free! At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

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