In some ways, reading stock charts is like being a stock psychologist.
The behavior of price and volume can tell you a lot about how the market is feeling about a company, and skilled stock chart reading can help you spot changes in investor mood. The concept of overhead supply is one of those emotional turning points.
Many investors who don’t follow proper sell rules go through this sooner or later: A stock goes down and your losses start to pile up — 20%, 25%, maybe more. But then shares rebound and the hope of reducing or eliminating the loss brings a smile. If the stock gets within 10%, 5% or less from the purchase price, you sell — thankful to have reduced your losses. If you break even, it feels like you won.
Thousands of investors share the same thinking, and that’s what produces overhead supply. As the stock get closer to its prior highs, selling picks up as more investors reach their get-me-out-of-this-mess price target.
The mass of investors itching to sell represents pent-up supply of shares on the chart.
This is how to spot it on charts:
After a winning stock suffers a long and deep decline, watch what happens as shares get closer to prior highs. A recovery that stalls around former highs is likely battling overhead supply. But this excess supply doesn’t last forever. IBD research shows that after 18 months to two years, the effect of overhead sellers fades away.
Stock Chart Reading Spots Overhead Supply
By the time the stock peaked in March of 2014, a large mass of investors owned shares. On an average day, more than 1.3 million shares were traded.
Many of those investors sat on losses as Ubiquiti suffered a 46% plunge in seven weeks (2).
A buy point at 47.88 in September (3) came just six months from the peak.
No doubt, many of the investors hurting from the February 2014 breakout took advantage of the strength to sell. The provider of network communications equipment spent months in a correction.
It took that long to wring out the overhead supply. The stock broke out in early May 2016 at 37.20, formed a base on base, and broke out again two months later. (That recovery period is not visible in the above weekly chart.)
Gains reached more than 73% until Ubiquiti started another base in February 2017.
This story was first published on March 8, 2019. Juan Carlos Arancibia is the Markets Editor of IBD and oversees our market coverage. Follow him at @IBD_jarancibia
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