I spend most of my time looking at the positive side of the market, trying to uncover the next big market winner with a revolutionary new product or service that’s changing the way we work or live. These stocks are at the heart of Cabot Growth Investor and are why we’re able to trounce the market’s returns.
But you can’t just have a good offense if you’re going to be successful in the market. You also need a good defense, meaning you have to be able to identify when a stock’s major advance has ended and you should book profits.
That leads me to Ambarella (AMBA), which has been one of the hottest growth stocks during the past year. Even as many chip stocks have done well, AMBA lit up the sky thanks to its camera solutions used in GoPro and other devices … and there was even talk that it will be a big beneficiary as the drone revolution gets going.
These positives, along with rapid sales and earnings growth, helped drive the stock higher and higher; after bottoming at 22 in May 2014, the stock broke out above 34 in August and ran into the high 70s this spring, where it consolidated tightly for a few weeks. Despite the big run, though, the action was normal—the right thing to do was to sit tight.
Then came another move to new highs in May. And then the roof blew off! AMBA soared from 78 to 128 after a frenzy of positive news and commentary, including quarterly earnings and all that drone talk. This move was what is known as a climax run—basically, a huge, straight-up move that occurs after the stock has already had a big, multi-month run higher.
Looking at the daily chart below, we see all the signs of a climax run. The stock ran up a huge gain (64%) in four weeks—at the peak, the stock was trading a monstrous 47% above its intermediate-term 50-day moving average, and an unreal 109% above its long-term 200-day line.
Moreover, on the weekly chart below, AMBA pierced its long-term channel line on the upside (almost always a sign of too much enthusiasm) and scored its two biggest weekly point gains during the run higher. And, of course, even before the last upmove, the stock had more than tripled in about nine months!
All of these are indications of a climax run. And what finishes the top is usually a big, decisive break off the top … which we saw right after the top, when AMBA suffered its worst daily loss on its biggest daily (and weekly) volume during the past year. There are no certainties in the market, but the odds strongly favor the stock having topped out for at least many weeks, and more likely many months or longer.
Throughout history, many of the market’s biggest winners top out with climax runs. Unfortunately, most investors miss it because they get caught up in the stock’s run higher, which usually comes on fantastic news, upgrades and the like. But if you’re keeping an open mind and watching the chart, you can start to peel off shares as the stock reaches its top.