How do stocks make parabolic moves?

In the stock market, when something is described as “parabolic,” it usually refers to a sharp, rapid, and often unsustainable rise in the price of a stock or a market index. The term “parabolic” is used because the price movement on a chart resembles the shape of a parabola — a curve heading higher that gets steeper and steeper.

This parabolic rise typically happens when there’s intense buying activity, often driven by speculative behaviour, hype, or fear of missing out (FOMO). It may also be the result of a “bubble” where the price increases at an exponential rate, but without strong underlying fundamentals to support it.

In the stock market, a parabolic move often signals that the price increase is too fast to be sustained for the long term. Investors may start to worry about a correction, where the price could drop just as quickly as it rose.

Risks of parabolic stocks:

1.Excessive Valuation

When a stock’s price rises sharply without a corresponding increase in its fundamental value (like earnings, revenue, or growth potential), it can become overvalued. Investors may be paying far more for the stock than it’s truly worth, leading to the risk of a major correction once reality sets in.

2.Speculation Over Fundamentals

Many parabolic stocks are driven by speculation and market sentiment rather than solid business fundamentals. For example, a stock may be soaring due to investor excitement about a new trend (like blockchain, electric vehicles, or a new technology) rather than the company’s actual financial performance or long-term potential. This speculative nature makes them volatile and susceptible to sudden drops when the hype fades.

3.Fear of a “Bubble”

A parabolic price increase often signals the formation of a market bubble. A bubble occurs when prices inflate far beyond their intrinsic value, and it can only be sustained for so long. Once the bubble bursts (often triggered by news, a market correction, or changes in investor sentiment), the price can fall dramatically in a short period of time.

4.Market Manipulation

Sometimes, parabolic moves can be influenced by market manipulation (e.g., “pump and dump” schemes), where groups of traders or investors artificially inflate a stock’s price before selling off at the peak, leaving others with losses when the price crashes. These manipulations can be difficult to spot and pose a major risk.

5.Psychological Impact

When a stock is in a parabolic rise, FOMO (Fear of Missing Out) can drive more and more investors to pile in. This creates a psychological “herd mentality” where people invest based on emotion and hype rather than sound analysis. When sentiment turns, the sharp decline can cause panic selling, further exacerbating the price drop.

6.Lack of Long-Term Stability

Stocks that rise parabolically often lack the stability of companies with strong, sustainable business models. The lack of solid underlying growth can make them prone to drastic corrections once the market realizes the stock was overhyped.

7.Unpredictability

Predicting the peak or end of a parabolic move is incredibly difficult. The stock could continue rising for a while before the inevitable drop happens—or it could crash without much warning. This makes it a dangerous investment for those who can’t afford to take on such high levels of risk.

Example of Parabolic Stock

An example of a stock that has recently gone parabolic and was therefore at risk of crashing back down was Droneshield (ASX:DRO). As we can see in the image below, these stocks can fall just as fast as they rise.

Source: Amibroker

Lauren Hua is a private client adviser at Fairmont Equities.

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