As a simple rule, from a swing-trading perspective, I just don’t not chase stocks higher that are going parabolic.
Thus, I’m apt to stay away from Tesla Motors (NASDAQ:TSLA), which has essentially doubled in roughly one month’s time. It doesn’t matter to me whether the magnitude of the move was exaggerated by a short squeeze, or trend followers having to chase the stock higher.
As it pertains to stocks that make vertical leaps, they often fall into one of four categories:
- M&A activity.
- Major product approval by a regulatory body.
- A lawsuit or other threat gets lifted or resolved.
- The company is discovered overnight to have the hottest product in the world.
In the case of Tesla, clearly No. 4 applies best. But however great Tesla cars are, chances are slim that by next week everyone and their grandmother will be purchasing two each — and thus the stock will soon have to put in some sort of a mean-reversion move lower. Much like with Apple (NASDAQ:AAPL), emotions are now running high in the stock and one would be wise to tread carefully when playing this stock, in either direction that is.
On the multiyear chart below, the recent doubling in the stock price marks the chart with a vertical spike higher. Also typical of such spikes, this rally in TSLA comes after a multiyear move higher in the stock.
On the daily chart, note that while the stock spiked higher, momentum as measured by the stochatics indicator has moved lower, thus flashing negative divergence vs. price.
While that’s a first bearish sign, it is by most accounts not enough to get leaning against the stock. Just like stocks that fall off a cliff, stocks with vertical moves need time to digest, allowing the emotions to settle somewhat before higher probability trades set up again.
In the case of Tesla Motors, only a major one-day bearish reversal move would get me interested on the short side for a trade, while playing the long side of the stock won’t fit my bill until the stock has either corrected a few percent or moved sideways for at least a few days.
Knowing when to stay out of a stock is one of the most important things to learn in this business. This is one of those times.
Serge Berger is the head trader and investment strategist for The Steady Trader. Sign up for his free weekly newsletter here.