Updated from Feb. 8, 2017 with latest share price level.
There is a very familiar pattern building in Nvidia (NVDA) stock and this pattern has extremely high "if/then" predictability. It's called a parabolic rally, and Nvidia's parabolic rally is nearly complete. It will be followed by a crash in the stock's price.
In an article published in December on Real Money, we wrote that our decision support engine was warning of an imminent peak and reversal, regardless of any corporate news. This is because of the crowd's complete adoption of bullish certainty that Nvidia's business prospects not only can result in its share price continuing higher but must result in nothing but a rally.
On Thursday afternoon, shares were trading at $117.86, down 75 cents, or 0.6%. The company plans to report its fiscal fourth-quarter results after the bell Thursday.
As you can see from reviewing that Real Money analysis, the same certainty was reached by the crowd as Qualcomm (QCOM) shares went parabolic into the late 1999/early 2000 peak. It was a fun ride in the final three months, which took Qualcomm from the low $20s to the high $70s, but the crash came fast and furious and spelled big losses for those who bought shares late in the rally.
If you are telling yourself "It's different this time," remember that those four words are the most dangerous four words in the investment world, as human subjectivity and ego-attachment to being right never change.
If you're telling yourself that you know how to speculate in parabolic rallies and won't get caught in this one, you might be right, but only if you can remove your human nature. This is because the final days of parabolic rallies are characterized by irrational belief in the greater fool theory. That the concept that it doesn't matter what crazy extreme a stock is at the time you buy into it, as there's always a greater fool than you who will buy it from you at a higher price. The greater fool theory works perfectly until it becomes clear that the face in the mirror is the greatest fool. Things get very painful from there, as prices fall even faster than they rose.
Following is the updated monthly bar chart from our analysis of Nvidia stock, with some benchmarks added to highlight how close to the reversal Nvidia shares now are. Notice the proximity to the olive/gold line, which is the two-standard-deviation band (which controls 95% of normality); the orange line, which is the three-standard-deviation band (controlling 99.7% of normality); and the red line, which is the four-standard-deviation band (controlling 99.9% of normality). Any of these extremes can be reached this month as the mania blooms. History shows, however, that the only survivors will be those who exit a little early, rather than a little late.Click here to see the following chart in a new window
The expectation for the quarterly results is tremendous. The most common rationalization is that the company's chips are dominating the field in the automated, self-driving and connected-car industries. In 1999, the rationalization for Qualcomm's infinite rise continuing had a similar flavor. Nevertheless, Qualcomm stock couldn't avoid a post-parabolic crash. Neither will Nvidia. History shows that all parabolic rises end with prices returning at least to the origin of where the rise began. For these shares, that could be one of the two support zones highlighted in green on the chart. Either $77 +/-$8 or $30 +/-$5 appear to be the lift-off points of the vertical phases of the rally.
The DSE objective eye has just reiterated its prior warning to members of our Trading Room and Alerts services, and suggests that long exposure be taken off the table before the end of February, while using the lower boundary of the pink sell box as the worst-case sell-stop level. The only action that is indicated under these conditions is a selling action. This means if you are long, sell to exit your position and capture the fabulous profits you've been lucky enough to have received. If you're flat, you could sell short shares of the stock to establish a bearish position anywhere in the pink sell box. Ideally, you should "ladder" in to short exposure, as the final days of a parabolic rise can be like Fourth of July fireworks. Extreme caution is suggested for both bulls and bears, but the risk of the moment is skewed heavily against those remaining long too long.
Here's what Jim Cramer thinks about chip stocks:
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