“Just remember buying at new highs is buying into emerging strength.” – William J. O’Neil
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 breakeven, I will sell.” This can add enough selling pressure to thwart a stock’s advance unless there is overwhelming demand.
Current market scenario: On April 19, we had changed the market direction to a Downtrend following our rules on market direction. Nifty had corrected over 6.5% from the peak it made in February. Accordingly, most of the stocks had also corrected from their peaks. Thus there is overhead supply concern in many of the stocks.
Using MarketSmith India charts, it is easy for individuals to find out the amount of overhead supply. It is represented as “OH” on charts. For educational purposes, we have taken a daily chart of HDFC Bank to indicate the “OH” on our charts.
For example, let us say a stock makes a run from 50 to 100 a share and then tumbles back to 75. Now, if a buying area emerges around 85 and you end up buying at that level, chances are, you are facing people 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 weigh on 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.
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Read our last week’s article:What’s a Follow-through Day?