Sell When a Blow-Off Top Occurs

I like to call the blow-off top "my friend Spike" because the pattern is so easily recognized after the fact by the distinctive spike in the chart.

Sometimes a stock advances very quickly in a short period of time - days or just a week or two. It contrasts sharply with the previous action of the stock which may have been advancing steadily for some time. All of a sudden there is a sharp spike upwards. This is called a blow-off top. And it is a good point at which to sell.

What is happening here is that all of a sudden, everyone and his uncle has discovered the stock. Maybe a new analyst report touts a much higher target for the stock. Or a recent excellent quarterly report gets noticed. Or some exciting news has caught the public's imagination.

In any event, everyone decides they better get in on this stock before it's too late. Blow-off tops are usually accompanied by a large increase in trading volume, reflecting this surge of interest. The problem is, at that point, it's already too late.

The best way to understand this is to look at an example. Consider one of the best performing stocks of 1999 - Qualcomm (QCOM - NASDAQ). This stock just rose steadily for most of the year. Then, in mid-November and at the end of December, the stock took flying leaps upward. Click on the button below to get a pop-up page from BigCharts illustrating this point.

Each case was accompanied by increased trading volume. In the first case, QCOM jumped from 224.81 on Nov. 2, 1999 with a volume of around 5 million shares to 260.50 the next day on volume of around 14 million shares. That's a 15.9% jump in one day. The company issued a strong quarterly report on that day. And the stock continued to soar - peaking at an intraday high of 406.13 on the 15th. Total gain in two weeks - 80.7%.

The stock then moved sideways for a while before starting another steady climb. On Dec. 29th, with the price at $503, Paine Webber analyst Joseph Galone initiated coverage with a Buy rating and a target of $1000. The market went nuts. The volume tripled the next day and the stock surged ahead to $659 - a gain of $156 or 31.0%. Everybody believed Galone.

The following day saw the stock surge to an intraday high of $740.13 only to drop back and close at $647. The next day - the last day of the year - the stock split 4-for-1 and surged again to close at a pre-split price of $704.52. Then on January 3, the first trading day of the New Year, the stock surged ahead to an intraday high of $800 pre-split and a closing price of $717.24.

And that was it for Qualcomm. The stock never regained that heady high. Those hanging on waiting for that magic $1000 figure were treated to a drop of 75% by mid-July 2000.

So how do you spot a blow-off top? Why was the November surge a natural step-up and the second a blow-off top?

Actually, the November climb could have been a top. A surge of that magnitude can go either way. And many such surges are steps along the road to further gains. A stair-step pattern of surging gain, consolidation, surging gain, more consolidation and then more gain, is not uncommon. Very few stocks climb steadily and consistently upwards week after week like Qualcomm did for most of 1999 before November.

In his best-selling How to Make Money in Stocks, William O'Neil lists 36 selling guidelines, several of which relate to blow-off tops. They are:

In our example of Qualcomm, blow-off top signals were given with both the November and the December run-ups. Prudently, an investor could have sold right after the first run-up started to level off, and then bought back in when the stock once again hit new highs in early December. If the stock had broken to the downside instead of resuming its advance, the investor would have been covered.

Similarly, an investor should have sold right after the second day of the advance in December when the failure of the stock to hold its intra-day gains indicated weakness. Or, anticipating a run-up on the stock split, the investor could have sold right after the stock split when again, the stock couldn't close near its intra-day high.

Qualcomm had one other factor indicating a possible top in December - Galone's bold assertion of a $1000 target price. O'Neil reiterates Jack Dreyfus admonition: "Sell when there is an overabundance of optimism."

Qualcomm is a superb example of the blow-off top, but there are many others within the last year. Corel in December 1999. Tecsys in March 2000 (which had three consecutive blow-offs, the last of which was the final one.) Sierra Wireless in late February 2000. In fact, almost any high tech and/or Internet stock exhibited a blow-off top formation in late February and early March 2000.

The only reason people hang on to a stock after a blow-off top is simple greed. They aren't satisfied with their double, triple, or even ten bagger. They believe the gravy train will go on forever. It doesn't.

The only exception to the rule is a stock that is the subject of a takeover bid at a premium price. It may exhibit the sudden run-up in price typical of a blow-off top, but the price has no reason to fall back unless the deal falls through. And if the deal involves an exchange of shares - as in the current takeover of Janna Systems by Siebel Systems - the thing to watch is the company taking over. If its shares aren't exhibiting a blow-off top pattern - then the shares of the company being taken over are safe to hold for the interim (barring other factors).

The only hazard of selling on a blow-off top is the possibility that the stock may, in fact, advance further as evidenced by the November jump in Qualcomm. But selling, with the possibility of buying back in when the stock hits a new high, is better than being caught with your pants down.

Advantages	Disadvantages
Get out with a nice profit	Could be a stepping stone to further gains rather than an ultimate top
Avoid a sudden and drastic decline	Must be careful you don't sell a stock that's rising quickly on a takeover bid

Stock Selling Strategies Sell When a Blow-Off Top Occurs