Ulta Beauty, Inc. (ULTA) stock became a falling knife after the cosmetics retailer missed earnings estimates after the close on Thursday, Aug. 29. This crash pushed the stock below its "reversion to the mean" at $254.32.

When I profiled this retailer of prestige cosmetics before its earnings report released on May 30, I warned that the stock was in an "inflating parabolic bubble" and that bubbles always pop. Remember that an "inflating parabolic bubble" is confirmed when the stock's weekly slow stochastic reading is above 90.00 on a scale of 00.00 to 100.00. This was noted for almost the entire month of April.

The stock closed last week at $237.62, down 2.9% year to date and in bear market territory at 35.5% below the all-time intraday high of $368.83 set on July 17. This high was just below its semiannual risky level at $371.47.

Shares of Ulta Beauty plunged on profit warnings and multiple downgrades by Wall Street analysts. The company ended a winning streak of beating earnings per share (EPS) estimates for five consecutive quarters. A warning came from the fundamentals, as its P/E ratio was elevated at 28.58 without offering a dividend, according to Macrotrends.

Morgan Stanley downgraded Ulta Beauty stock to equal weight from overweight, cutting its price target to $275 from $395. Piper Jaffray downgraded the stock to neutral from overweight, reducing its price target to $250 from $360, citing "muted visibility." My charts were not muted and showed warnings before the stock reached its all-time high.

The daily chart for Ulta Beauty

Daily chart showing the share price performance of Ulta Beauty, Inc. (ULTA)
Refinitiv XENITH

The daily chart for Ulta shows the stock plunging below its 200-day simple moving average at $319.69 and its annual pivot at $308.40. This annual level was a magnet between Feb. 15 and March 12 and held on weakness following its May 30 earnings report. The stock is also below its quarterly pivot at $258.64, but it remains above its Dec. 24 low of $224.43.

The weekly chart for Ulta Beauty

Weekly chart showing the share price performance of Ulta Beauty, Inc. (ULTA)
Refinitiv XENITH

The weekly chart for Ulta was negative ahead of earnings and remains negative, with the stock below its five-week modified moving average of $318.13. The stock is below its 200-week simple moving average, or "reversion to the mean," at $254.32.

The 12 x 3 x 3 weekly slow stochastic reading declined to 40.78 last week, down from 54.24 on Aug. 23. At the April 17 high, this reading was 91.62, above the 90.00 threshold putting the stock in an "inflating parabolic bubble." This was a warning to reduce holdings, and my strategy missed the strength to the July 17 high of $368.83. I would rather miss that strength then suffer from the Aug. 30 plunge to $235.76. The parabolic bubble has now popped.

Trading strategy: Buy Ulta shares on weakness to the Dec. 24 low of $224.43 and sell on strength to the "reversion to the mean" at $254.32 and to the annual pivot at $308.40.

How to use my value levels and risky levels: Value levels and risky levels are based upon the last nine weekly, monthly, quarterly, semiannual, and annual closes. The first set of levels was based upon the closes on Dec. 31. The original annual level remains in play. The weekly level changes each week. The monthly level was changed at the end of each month, most recently on July 31. The quarterly level was changed at the end of June.

My theory is that nine years of volatility between closes are enough to assume that all possible bullish or bearish events for the stock are factored in. To capture share price volatility, investors should buy shares on weakness to a value level and reduce holdings on strength to a risky level. A pivot is a value level or risky level that was violated within its time horizon. Pivots act as magnets that have a high probability of being tested again before their time horizon expires.

How to use 12 x 3 x 3 weekly slow stochastic readings: My choice of using 12 x 3 x 3 weekly slow stochastic readings was based upon backtesting many methods of reading share-price momentum with the objective of finding the combination that resulted in the fewest false signals. I did this following the stock market crash of 1987, so I have been happy with the results for more than 30 years.

The stochastic reading covers the last 12 weeks of highs, lows, and closes for the stock. There is a raw calculation of the differences between the highest high and lowest low versus the closes. These levels are modified to a fast reading and a slow reading, and I found that the slow reading worked the best.

The stochastic reading scales between 00.00 and 100.00, with readings above 80.00 considered overbought and readings below 20.00 considered oversold. Recently, I noted that stocks tend to peak and decline 10% to 20% and more shortly after a reading rises above 90.00, so I call that an "inflating parabolic bubble," as a bubble always pops. I also refer to a reading below 10.00 as "too cheap to ignore."

Disclosure: The author has no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.