Blow off tops are a trading pattern that, being notoriously hard to trade, can be both very risky or very rewarding if you can identify one. In this post, we’ll go over what it is, how to spot it, and how to trade it.
A blow-off top is a pattern on a chart with a steep increase (well over 45 degrees) when excluding other factors, like broad market changes. This includes a high trading volume that fizzles and is followed soon after by an equally rapid decrease that usually has a high volume. Blow-off tops can occur in any asset market. This chart pattern will look like a steep volcano cone with a slightly lopped-off tip.
Hence the blow-off. And this tip is the ultimate high price for the asset. Generally, this high is short-lived.
How to Spot Blow Off Tops
Speculative assets are the most likely to have blow-off tops. Things like cryptos, vaccine makers, and pot stocks have all fit this category in the recent past, creating blow-offs with news like the passing legalization of marijuana in a state or even from the speculation of positive news like a tweet for a joke coin “#Doge barking at the moon” causing a 300% increase.
A price rise results in a monkey-see-monkey-do, FOMO (fear of missing out) attitude, bringing it higher with increased volume. Predicting a top and its duration takes a lot of work. And once a price drop starts, it’ll fall fast. The masses will panic and stop orders, and short sellers will bring it down even faster, making the drop difficult to gauge. So, make sure you know how to spot a blow-off top pattern.
ETH Example
Starting in July 2020 through to April 2021, ETH went up from below $250 to over $2000. There were only a few hiccups along the way.
The top lasted from May 11th, when it peaked at $4330, till May 14th, when it quickly declined to $2400. By May 18th (highest volume day) to where it stood in June 2021 at just over $1700 with only a few bumps.
What Causes Blow Off Tops?
Asset rises with no pullbacks
This is the easiest to identify. The asset will either have gained over 79% with no retracement, risen for six months or more, or risen over 100% and up to 500% or more.
High volume
Volume is the key identifier. On the day of the blow-off, the volume must increase and remain high as the sell-off pushes the price downward.
Downward slide is extreme
After a FOMO rise where profits seem endless, smart money has continually set stop losses to take profits. A potentially minor event causes panic selling. And the drop is quick and extreme now, easily identifying the blow-off top.
Minor or major top
The broader market can bring shareholders to their senses, seeing the asset drop and the market not believing in a recovery. This also results in panic selling.
Counter-rally has volume to it
After the initial sell-off, any counter rally is unimpressive with its price or volume. This is aptly named a “Dead Cat Bounce.” And those with long positions will use the reprieve in plummeting prices to unload their holdings. To prevent a margin call, short sellers will set up better positions to take advantage.
How to Trade Blow Off Tops
This will depend on your current position and when you got in. You’re not the first if you have misidentified a blow-off top or made a bad trade.
But it’s usually best to exit your position early on and not be left holding the bag. Falling for FOMO and buying too late can mean huge losses when that price begins dropping and fails to return to previous levels.
Likewise, short-selling a blow-off too early, assuming a pull-off in a strong rally is a top, can also result in substantial losses if the position isn’t closed quickly on the continued rise.
Don’t let emotions control your trading. Plan your trade and trade your plan. Stick to what you know works for you.
When you deviate, you get into trouble trading things like blow-off tops.
You went long at the top
You fell into the FOMO after a runup that seemed never to end. Now, down 75%, you have a hard decision. You need to take a fundamental look at the company and either hold (years) till you get some back (it must go up 300% now to break even). Or, if you believe in your trading skills, look for the first bounce, take your licks, and buy something else with more potential.
You bought after the fall
Now that you have chosen the perfect buy point, you may get overconfident about the climb. Don’t fall into the same trap. It is time to sell again if you see a 50 to 79% retracement. Rarely will blow-off tops reach their highs in the short term. When you get to 50% retracement, you have doubled your money.
Sell 50% of your holdings, and you will be playing with the casino’s money from then on. If it climbs higher, set a stop at the 50% retracement price, a sell of another 25% (half your remaining) at 60% retracement(set a new stop at 55%), and the rest at 79%.
Final Thoughts on Blow Off Tops
Managing money and setting stop losses is crucial to prevent large losses and can also ensure profits. As always, never put more than you are willing to lose at risk. Make sure you know how to spot a blow-off top pattern. Those who successfully identify blow off tops have a unique opportunity to capitalize on the overreaction of other traders. However, predicting a top, its duration, and to what level the fall reaches is nearly impossible.
Frequently Asked Questions
Depending on the market, a blow off top can last for weeks. Thus making it very hard to judge when the cliff will come. A blow-off top can either result from positive news or market participants' speculation. Blow-off tops can also be known as an “exhaustion move” or a “blow-off move.”
Buying a blow off top means that you are purchasing a security that is rapidly moving. It can be risky for traders if they purchase at the top without getting the proper entry.
A blow off top signals that the steep uptrend is about to lose momentum, typically resulting in a steep decline in a securities price.
