What is Overhead Supply?

A challenge impacting investors is buying a stock that is breaking out to new highs. Emotions take control and beliefs set in about missing out on the upward moves. Buy orders increase at the highs, share prices top out and the stock declines.

Prices fall up to 25% or more, and anyone who is purchasing at the highs is looking at substantial losses. Negative emotions take control and investors sell, cut their losses and move on.

The stock moves past the old high and sets a new one. Situations like this happen when overhead supply exists. Here’s why. 

Overhead Supply Defined

Overhead supply is when the price of the stock is sitting below the highest value. Investors bought shares at higher prices and are down in the stock. As the stock moves back up, these investors sell shares and limit the losses. These investors are looking for a move back to the peak just to sell. 

An Example of Overhead

In February 2021, Moderna (NASDAQ: MRNA) ran to the all-time high of $180. Investors purchasing the stock at these levels rode the volatility, with prices dropping to $125 in April. MRNA ran back up for a retest of the overhead supply and selling increased to limit losses. As investors locked in the losses, the shares rebounded, the stock broke through $180 and moved higher. 

What Lessons can Overhead Supply Teach you?

The laws of supply and demand dictate what happens with stock prices. Overhead supply develops when the stock runs up to new highs and investors become excited about the movements. A feeling of enthusiasm grows and investors buy the stock or stock index at the highs. The stock overextends and prices drop. 

The average investor needs to understand how overhead supply impacts stock prices. An ample supply builds up under the highest price that is waiting to break even or sell.

As the supply builds, the prices drop and start to climb back up. A peak develops once all of these investors sell the shares they bought at the stock’s highs.

The massive supply causes shares to fall because of the enormous number of sell orders.

If prices trend upward, more investors might jump in and the cycle will begin again. 

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When to Avoid a Stock

Watching the overhead supply helps in deciding when to avoid the stock and improves the entry points. The key is not to buy shares at the highs and to monitor the stock after share prices drop. Nervous investors will sell to limit their losses, and the cycle can resume until these sellers become exhausted.  

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