Overhead supply is a term technical analysts use when a stock has been reached a resistance level where buyers have bought at previous highs but the stock price has now dropped and they are now waiting to sell near or at their entry price to break even.
When does overhead supply occur?
A stock may have rallied to all time high but then starts to fall from this level. Buyers who have bought the stock at the high are now at a loss and waiting for the stock to recover back to their entry level so they can exit the position with a small or no loss. This activity causes a resistance level as there is are more sellers than buyers at that point and sellers are just waiting for the stock to hit this level to sell out and recoup their initial investment.
Investor A has brought a stock called XYX at an all time high of $60, the stock then falls sharply back to $40 and the investor now is making a loss. A sell level of $60 or somewhere close to that is in the mind for the investor as they would be happy to just break even or take a small loss at this point in time. So once the stock starts to rise from the $40 level, sellers will have the level of $60 or somewhere near to sell out of this stock. This creates a resistance level near or just below the $60 mark as there are a lot of frustrated investors hoping to just liquidate this position.
There is a psychology term called “loss aversion” which means people prefer to avoid losing money than making money. Investors feel more pain when losing on a stock compared to the joy when an investor makes a capital gain. The reasoning behind the pain of a loss is the investor is losing money they previously had but with a share gain, the investor never had that money in the first place so a win is just extra money. This loss aversion creates the overhead supply where investors hold on to losing stocks until they can exit at breakeven levels or at a small loss.
Lauren Hua is a private client adviser at Fairmont Equities.
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