What is a Blow-Off Top
A blow-off top is a chart pattern that indicates a steep and rapid increase in a security’s price and trading volume followed by a steep and rapid drop in price and volume. The rapid changes indicated by a blow-off top, also called a blow-off move or exhaustion move, can be the result of actual news or pure speculation.
BREAKING DOWN Blow-Off Top
A blow-off top usually indicates that a security’s price is about to fall, while a blow-off bottom suggests that a security’s price is about to rise. A security also can enter a blow-off period during which its value remains inflated for weeks or months. Often times, momentum stocks experience blow-off periods during their violent upswings and downswings.
For example, a common blow-off top pattern occurs when a pharmaceutical company announces the results of a pivotal clinical trial. A failure to meet clinical outcomes tends to be a disaster for early-stage biotech or pharmaceutical companies, but optimism leading up to the FDA’s announcement date can lead to a price spike. Another example may be the initial public offering of a tech startup that has been hyped prior to the IPO date.
Traders who want to profit from blow-off periods and limit their potential losses can use trailing stop techniques, while blow-off tops can also be helpful for identifying potential gap-n-go trades. The key to success when trading blow-off tops is properly identifying them and ensuring that they aren’t simply prolonged uptrends – especially if traders are looking to make a contrarian trade.
Identifying Blow-Off Tops
Traders may find it difficult to accurately identify blow-off tops. Early on, blow-off tops may appear similar to strong rallies. That can make it difficult to initiate a short position to call a reversal, as well as potentially too late to buy into a long position if the stock has already risen sharply.
Some common characteristics of blow-off tops include:
- No Pullbacks: Blow-off tops have experienced massive uptrends with no substantial pullbacks, which differentiates them from stocks that are simply in a long uptrend.
- Bearish Volume: Blow-off tops are followed by sharp moves lower on massive volume, which indicates that long traders are exiting the stock in droves.
- Broader Market: Blow-off tops are often exacerbated by wider market conditions, which means that a broad market sell-off could lead to a move lower.
If traders have misidentified a blow-off top or traded it wrong, it’s often best to exit the position early on to avoid becoming a bag holder. Those who successfully identify blow-off tops have a unique opportunity to capitalize on the overreaction of other traders.