Education: Overhead supply and admitting mistakes

I, like everyone else, hates admitting I’m wrong—especially to myself.  

Jason over at InvestorGeeks has started his foray into technical investing by looking at Microsoft through the lenses of support and resistance levels. His article points to the way that MSFT is trading in between a range of support on the downside and resistance on the topside, something that’s fairly common in big name stocks.  

His post touched on an occurrence called “overhead supply”, something that I think we will see a lot more of soon.  

Overhead supply occurs when a stock reaches a point where it had been for a long time, and since fallen.  There, the stock finds an immense amount of selling pressure.  You may think that this is just nonsense with no reasoning, but it actually all comes back to my not wanting to admit my mistakes.

The investing community is a lot like me—they don’t want to admit they’re wrong. They especially don’t want to admit they’re wrong with their money.  Suppose MSFT has been trading at $26 for weeks. That means for weeks, people were buying it at $26, which was their perceived approximate value. Then BAM! MSFT tumbles. Everyone feels frustrated and slightly embarrassed—until the chance for redemption comes, that is.

If it regains its bearings, everyone who was in at 26, or got used to 26, will be waiting for that watershed mark.  Once it hits, they will simply want to close their position for breakeven and a small loss simply to prove to themselves that the stock was worth what they paid.  It’s not smart, it’s not pretty, but it is how the subconscious works.  

The same pattern occurs when a stock that lagged heads toward it’s old 52-week high.  Everyone remembers that number and they want to get out where they wished they had before.  This leads to immense pressure at the top and it is a partial explanation of the commonly cited double-top pattern.

This may seem overly simple, and it’s not always true.  But it is likely to be true, meaning it is of some value.  I’ll be sure to follow up with some more rationales about stock patterns in upcoming posts.  

Flaws (like not accepting mistakes) can be useful… as long as you can predict others will share them.