Overhead Supply

The best time to buy shares in the market is when the supply of shares begins to dwindle. In laymen terms, it is a time when the sellers have done their selling and starts to disappear. As soon as there are no more people selling the shares, the price will be free from a burden of supply and ready to go higher.

In the stock market, there are two kinds of people who are desperate to sell their shares to take a profit. The first group of people are the trapped buyers. They bought their shares just before the market corrects and heads lower. As a result, they were sitting with a loss. They become so frustrated that they cannot be more eager to see the next rally to come and get out even.

The second group of people are the opposite of the first group. They are the clever fellows who have just bought near the low and seen the share price rally immediately. They congratulate themselves for their brilliant insight and meticulous timing. However, they are simply short-term traders who are not interested in holding their positions for the long-term. They are also looking forward to seeing the price to get back to its old top to take a profit.

These two groups of people are selling their shares for different reasons, but they are nevertheless trying to do the same thing: to sell shares at a price level around its previous high. So, as soon as the price rallies to the high, you see these holders selling their shares and the price pulls back. Of course, not all of them sell immediately. They may suddenly change their mind and think, “Well, if it goes up again, it may actually go higher. I better hold a little longer.” 

Usually, to their dismay, the price will correct again as a result of the first wave to selling. These remaining holders regret and vow to sell on the next rally. As a result, there is another wave of selling as the price approaches the top. Again, not all holders sell on the second rally and it is only now they regret and sell on the third rally, and so on. These repeated selling and rallying near the top of the price area creates a horizontal area known as the “resistance” on the price chart.

As the number of sellers decreases each time after falling back from the resistance level, the extent of the pullback of each selling will become smaller and smaller. On the price chart, you can see the price curve forms a consecutive number of smaller and smaller V’s on the graph. At the same time, you may also find the daily trading volume starts to dry up, which is because less and less existing holders are willing to sell. Different investors have different names for this situation. William O’Neil (e.g. 2009) calls it a “handle”, as often seen in a Cup with Handle pattern. Mark Minervini (2013) calls it “volatility contraction”. 

Regardless of how it is called, it is a time of low trading interest in which just a slight push by the big holders can significantly drive the price higher, if they are still interested in owning the shares. On the day they do it, the trading volume will increase to several times of recent average. Say, the twenty-day average volume is one hundred thousand shares. If the big buying happens, then one can easily see one hundred thousand shares of volume already reached in the first two hours of trading. This is exactly when you should buy, because a new up-move is very likely to be on the way.

REFERENCE:

Minervini, M. (2013). Trade like a Stock Market Wizards: How to achieve superperformance in stocks in any market. New York, NY: McGraw-Hill Education.
O’Neil, W. J. (2009). How to Make Money in Stocks: A winning system in good times and bad (4ᵗʰ edition). New York, NY: McGraw-Hill Education.