Many traders and investors love to see and find a good breakout pattern on the charts. While breakout patterns are great we must know when they become parabolic. Parabolic charts are often the time to sell out of the trade. A parabolic chart is when the stock price rallies sharply higher in a very steep angle on the charts. Often, when a stock surges sharply higher without pulling back it can only travel so far before the owners of that equity will start to sell out of the position.
For example, the other day First Solar Inc (NASDAQ:FSLR) soared after reporting some better than expected guidance. Many short sellers were caught off guard causing a short squeeze in the stock. The stocks rallied higher by $14.00 on the trading day from around $27.00 to $41.00 intra-day. This type of surge is what we would call a parabolic intra-day move. Now we can only wonder who was buying the stock at $41.00 after that enormous intra-day bounce. Some of the buyers were the short sellers that had to close out their position and other buyers were likely the misinformed retail traders trying to catch the momentum in the stock. Either way, when you see an equity rally in that type of steep formation it is unsustainable and the equity will pullback. Today, FSLR stock is trading around the $37.00 level. The idea here is to make sure that you do not chase the equity when it reaches extended levels. Traders should wait for the equity to pullback and form a pattern that will signal further upside again.
Another good example that occurred recently is the chart of Bitcoin. This is the virtual currency that has soared recently from under $10.00 to over $200.00. Many investors and traders are asking why the virtual currency sold off so sharply after trading above the $200.00 level. The reason is the same as any other equity, it traded in a parabolic manner that is unsustainable.
In March 2012, the same type of pattern occurred in a stock called Broadvision Inc (NASDAQ:BVSN). This stock surged from $10.00 a share to $55.00 a share in just two months. That type of pattern is again unsustainable and the traders and investors that caught the move are going to sell out of the position at the highs. That stock plunged from the high of $55.00 a share back down to $10.00 a share in just three months.
The same parabolic patterns repeat over and over throughout history on all time-frames. Traders and investors must simply know that it is not prudent to chase an equity when the chart pattern moves up in a very steep angle. Knowing this pattern should help to keep a lot of novice traders and investors out of buying equities that have already made their momentum move.