Decade after decade, new bull markets serve up big, new market leaders. Excellent fundamentals and increasing mutual fund ownership are two main catalysts for huge gains for select stocks. But all good runs eventually come to an end. It’s true in sports and it’s true in politics, but it’s especially true in the stock market.
What causes a stock’s run to end? By and large, it’s institutional selling — when fund managers decide to liquidate large positions and take profits after a big price run. So after a stock’s lengthy run-up, it’s always important to watch for signs of heavy institutional selling.
For a market leader, the 50-DMA, which computes a running average of price closes over the past 50 trading sessions, can act as a support level during an uptrend. But it can also act as a resistance level during a downtrend. If a stock breaks below the 50-DMA line in heavy volume and can’t rally back, it’s often a signal that buying demand is drying up and the stock’s run is ending. Keep in mind that one or two bursts of institutional selling can often presage more sales ahead. Sometimes, it can take a fund several weeks to exit a position.
Studying the price action of former market leaders just before they broke down can help you act quickly when a current leader you own starts to falter.