“Just remember buying at new highs is buying into emerging strength.” – William J. O’Neil, MarketSmith Founder
Have you ever wanted to go out with friends, but faced opposition from your husband or wife? The concept of overhead supply works kind of the same way.
Overhead supply, also known as percent off high, represents price levels at which a stock’s recovery is impeded as it tries to rally back from a steep decline. The pressure comes in the form of investors who bought the stock earlier at lofty prices and are waiting for the stock to recover just enough so they can sell and break even.
In essence, these are the holders who are thinking “If I can just get back to even, I will sell.” This can add enough selling pressure to thwart a stock’s advance, unless there is overwhelming demand.
For example, let us say a stock makes a run from 50 to 100 a share, and then tumbles back to 75. Now, suppose a buying area emerges at 85. If you buy at that level, chances are, you are facing those folks who bought at the 90-100 level. As soon as the stock is back around their purchase price, they will unload shares. Conventional market wisdom says to buy low and sell high, but overhead supply is one reason to buy stocks at or near their 52-week high. At those levels, there’s little or no resistance to work through. That is why it is a good idea to buy stocks just as they are breaking out of sound bases into new high ground.
Overhead supply doesn’t drag a stock forever. According to research, its effects diminish after 18 to 24 months. In other words, after a while, fewer shareholders are still around waiting for a price recovery to eliminate their loss.
So, before you buy a stock, study its chart carefully and check for overhead resistance.