What is Toppy

Toppy is a slang term used to describe markets that are reaching unsustainable highs. The term toppy may be used to describe a stock, sector or broad market index, such as the Standard and Poor’s 500 index (S&P 500), that has had extended gains, but there is analyst sentiment or a general market consensus that a potential reversal is imminent.

BREAKING DOWN Toppy

A toppy stock market climbs to new highs then retraces. Investors refer to a retracement as a pullback, a dip or a correction, in the case of a 10% decline.  As of July 2018, many analysts believe that the technology sector is toppy, citing excessive valuations.

Identifying a Toppy Market

Chart Patterns: Technical traders can use chart patterns, such as a double top or a head and shoulders top, to identify toppy price action. For example, in the chart below, TD Ameritrade Holding Corp. formed a swing high in early March 2018 and another swing high in early June 2018, giving the stock a double top before prices entered a correction phase. Topping chart patterns that form over several months are typically more reliable than toppy price action patterns over shorter periods. (See also: Identifying Tops & Topping Patterns With Surprising Accuracy.)

Example of a Double Top

Image depicting a chart of TD Ameritrade.

Reversal Candlestick Patterns: Traders have been using Japanese candlestick patterns to spot toppy price action dating back to the 16th century. Popular candlestick reversals include the bearish engulfing pattern, the piercing line pattern and the hanging man pattern. All of these candlestick patterns occur near the concluding stages of an uptrend and show a physiological change in investor sentiment.

Bearish Divergences: Toppy price action often accompanies a bearish divergence between the price of a security and a commonly used technical indicator, such as the relative strength index (RSI) or the stochastic oscillator. For instance, a bearish divergence occurs when the price of a security makes a higher high, but the indicator makes a lower high. Many traders use a combination of chart patterns, Japanese reversal candlesticks and bearish divergences to help locate a toppy stock or market index.

Fundamentals: Investors also analyze a stock’s fundamentals to determine if the issue is toppy compared to its peers and/or sector. The working capital ratio, quick ratio, price-earnings ratio (P/E ratio) and debt-to-equity ratio are just a few of the many metrics available to analysts and investors to asses the financial health and performance of a security. (For further reading, see: 6 Basic Financial Ratios and What They Reveal.)