Overhead Resistance and Your Swing Trading Strategy
Looking at the biggest winners in our alert service over the past year, one thing becomes clear. Overhead resistance is an important consideration when sizing up a potential swing trade.
Today we will talk about overhead resistance and why its important for swing trading but not as much for investing over the long-term.
These concepts are important so we can understand why SMCI, ELF, CELH, NVDA and others went up 50% to 1,000% over the past year within months after we featured them.
What is Resistance in Trading?
Resistance is a point during a rally where a stock tends to change direction and starts to trend lower.
The resistance is often a fixed price point that can be seen on a long-term stock chart. For instance, a stock may be trading around $40 but as the stock rallies and reaches $50 resistance, it begins to trend lower again.
The more times it finds resistance at $50, the stronger we would consider the resistance. Three or more times and the resistance becomes more important. At that point, a break above $50 potentially becomes a more significant bullish breakout. Many other factors have to be present though for us to consider a bullish trade in this case.
Resistance can also come in the form of a moving average, the top of a confirmed downward or upward sloping channel, the top or center point of a bollinger band, a fibonacci endpoint, or other technical measure.
The more common and usually more significant resistance for swing trading is a fixed price point where a rally in the price tends to stop and reverse historically. Again, this can be seen on a long-term stock chart. Here is an example of NVDA when we last featured it a little before a massive breakout and near 50% move higher within several weeks.
Charts courtesy of StockCharts.com
Most Significant Points of Overhead Supply
These overhead resistance price levels are also referred to as overhead supply. Meaning, many buyers are just waiting for “their price” to sell more of their supply of shares. In the first example above, this price is $50. With NVDA in the chart above, this price was just over $505.
The price moves lower when it hits overhead supply because more sellers come in with their supply of shares at the $505 price level to overwhelm the buyers and begin to change the trend to the downside.
When supply overwhelms demand, prices start to fall as with anything else whether its shoes, oil, shares of a company or most anything else for that matter.
A stock may be stuck below a key overhead supply level or resistance for months, years, or even forever.
2 of the most important points of resistance or overhead supply are the 52-week high and all-time high. Another is a key resistance level in a bullish base pattern that has developed over at least 5 weeks such as the high in the handle of a cup with handle pattern.
How to Use Overhead Supply to our Advantage
Many of the biggest winners in the daily alert service over the past year had the classic signs of a big winner.
Earnings and sales were growing strongly, the stock was already in a long-term uptrend, the price formed a bullish consolidation and the price was breaking above resistance right after big news.
Most of our biggest winners tend to be within 30% of all-time highs or at least 52-week highs. Most traders were concerned when NVDA gapped into all-time highs last May but since then the stock has more than doubled. Earnings have actually grown much more than the stock price increase. The forward P/E is still below the long-term average for the stock.
Studies show that stocks breaking out of bullish chart patterns just below or above new highs tend to perform better over the next year or two. And especially over the next couple months. We find this to be true if the fundamental growth factors are present before the breakout.
After several years, the performance tends to be pretty similar especially over periods that include a long-term market consolidation where you have large market corrections.
Here is another example of a stock we featured to customers just before the bullish market signal in early November of last year. Again, it broke through overhead resistance on big news just before a near 50% move in about 3 months.
ANET is another example where the overhead supply corresponds with all-time highs. A swing trade that worked well after a great earnings report and then selling some just before the next earnings release. It moved about 45% from our entry trigger price at the end of October within a few months. Notice how it holds the 30 day moving average as it trends higher.
Charts courtesy of StockCharts.com
Stocks breaking into New Highs Now
POWL is another example of a stock breaking overhead resistance into 52-week and all-time highs on great news. We featured it a few weeks ago just before the 50%+ move within a few weeks.
Again, the stock broke the overhead resistance shortly after great news before a strong trend higher that occurred quickly. These are the types of opportunities we need as traders.
As we say in our service, one way to keep a portion for a larger move is to hold a portion until it closes below the 10 day, 20 day or 30 day moving average. The stronger the uptrend, the shorter-term the moving average we can use. You can also wait for the first test of the 20 day or 10 day and a rebound into new highs again and then raise your stop to below the prior days low each day to exit the trade for a quicker swing trade. Large bearish candlestick patterns are also a good exit signal.
Another good opportunity came up last week for a stock with a reasonable valuation, strong growth and a big beat and raise quarter. The stock is APP. We already took some profits on an early entry and tightened our stop to ensure a profit and will look for other good technical entry points if it stops out.
Charts courtesy of StockCharts.com
The challenge with this stock is it has overhead resistance going back a couple years although its broken into 52-week highs with a lot of great fundamental signs. Growth is strong and accelerating, an upgraded product introduction is going well, and it has rapidly increasing cash flow yet a low cash flow yield.
So this one may experience more chop due to the overhead resistance. Chop meaning that the price will have larger swings up and down due to the overhead resistance and rally at a slower pace. A lot of investors who got in at a higher price a couple years ago may feel like bag holders and may unload on the spike in the stock. Some will do this.
This is the real concern with overhead resistance. We know we may have a lot of investors holding the stock that were down a lot during the bear market and its only human nature to want to sell once the price gets back to their entry point.
So this one may act more like NTNX and ESTC from last quarter that got off to a slower start but eventually grinded higher with a trend that grew stronger weeks later.
In Summary
So, when trading, overhead resistance matters. Its best to have no overhead resistance. Its even better to be breaking out of a base pattern just below the all-time high on great news such as was the case with SMCI all else being equal before a 200% move higher within a couple months.
Its no silver bullet to be sure. It just helps our odds of success a bit when swing trading for a big move from a good technical entry point.
So its just one more important factor to consider when sizing up a potential swing trade.
As the bull market continues, especially if the small cap indices finally get within 10% of the all-time highs, we should finally see more stocks within striking distance of all-time highs and break strongly out of overhead resistance before a potential big run in the weeks and months ahead.
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