Vertical Logic: Learning To Read Sell Signs Nearing A Climax Top
Master This Sell Rule: Investing Tips On When To Sell Stocks A climax run, also called a climax top, is an awesome thing to watch — especially if you own a piece of the action. But it also poses the difficult question of when to sell. It's obvious that the stock can't climb at that fast rate forever. A correction is clearly on the way. So when and how do you cut risks and take profits
To begin with, remember this basic rule: buy on fundamentals, sell on technicals.
Factors such as earnings, revenue growth, margins and so on play a strong role in determining whether and when you buy a stock. But a stock generally peaks while its fundamentals are still strong.
Technical signals, or the price and volume action shown on charts, reflect selling by large shareholders exiting the stock. These chart elements tend to get very busy and flash a flurry of warnings as a stock climbs toward a climax top. Learning to read them builds a valuable skill set.
Leading stocks often top out just after a powerful final surge in their rally. This surge is easy to see. But it tends to pit investors against their own desires. Hope that this stock will be "the big one" can easily blur sell signals.
Many investors holding Charles Schwab (SCHW) early in 1999 had such hopes. Here were the elements of the climax run.
• Sell Rule 1: After a big rally over several months to a year or more, look for an unusually rapid price run of, say, 25% to 50% or more over two to three weeks. The discount brokerage had gained an astounding 439% from an October breakout to its peak of 77.50 on April 14, 1999. In the last two weeks of the run, Schwab gained as much as 64%. This rise signaled a climax run.
• Sell Rule 2: Watch for an exhaustion gap. Schwab gapped to a new high on April 13 as volume screamed 272% above average. The next day, Schwab closed the gap, falling 8% in even heavier trade. The next three days of big declines showed that institutional investors had sold heavily.
Wary investors may have sold all or a portion of their positions at this point. Those who remained in the stock should have been on high alert.
A similar move had occurred at the end of 1999. Schwab marked an exhaustion gap on the trading day after Christmas; that big up day, Dec. 28, capped a startling advance of 82% in under three weeks. However, climax runs normally begin at least 18 weeks after a proper breakout. So this rally was still too early in the run to be a sell trigger.
• Sell Rule 3: Get ready to sell when a stock is trading 70% to 100% or more above its 200-day (or 40-week) moving average. At Schwab's peak, the stock traded 210% above the mark. The rise above the 40-week line rule isn't a sell signal on its own, but it is a solid secondary indicator of a stock making a near-vertical move.
• Sell Rule 4: A rapid price run-up for seven of the previous eight days in a row.
Schwab ended its run with a seven-day sprint, ending in an exhaustion gap of 11.5% — one of its largest gains during the advance — on April 13. The stock peaked the following session, ending with an 8% loss after a reversal in very heavy trade.
