Do you know it's possible to predict a market crash through stock chart analysis?
Today SlashTraders will use Tesla stock as an example to show the 3 common bearish signals, so you can react to bearish trends easily.
How Do You Know a Stock Is Overvalued?
We can read the TD Ameritrade chart to find the intervals where the stock price exceeded $390.
Now we know when TSLA is overvalued, we have the first bearish signal.
Use Bollinger Bands to Find Over Extended Prices
Bollinger Bands uses historical price data to model the statistical probability of future stock prices in a normal distribution. Its +/-2 standard deviation is a good reference to estimate the Implied Volatility to the stock.
There is only a 5% chance that a sample will occur outside +/-2 standard deviation (σ).
When TSLA stock price exceeds the upper Bollinger Band, we can say the price has overextended, and there is a high probability that the price will correct downwards.
TSLA price moved beyond the Bollinger Bands a few times in the past year. If the price penetrated the Bollinger Bands in a upward move, there would be a high probability a downward correction would follow.
Use RSI to Find the End of Overbought Conditions
RSI compares historical data with current price movements to determine whether the stock is in Overbought or Oversold conditions.
When RSI exceeds 70, the stock is Overbought and will likely continue to rise; while RSI is below 30, the stock is Oversold and will likely continue to fall.
If the stock price stays Overbought for extended periods of time, we expect the stock price to fall after exiting Overbought conditions.
The RSI analysis of Tesla price fluctuations shows TSLA were Overbought for long periods in the last year. When Overbought ends, there is a high chance the stock will fall next.
Now we know the 3 common bearish signals, we can use them to estimate when the stock price will fall. In our experience, when at least 2 signals appear at the same time, there is a huge probability the stock price will crash next.
If we overlay the 3 bearish signals together, we can see TSLA satisfied at least 2 bearish signals in both the start and end of January.
As expected, Tesla stock price fell in a big way after the end of January.
Take Advantage of the Down Trend by Selling Call At the Resistance
Since we can use bearish signals to forecast a price drop, we can sell a Call option at the resistance to be profitable from a bearish trend.
Since TSLA's last high point was $900, that could be the resistance to a future price correction.
We can take advantage of the end of Overbought in early February to sell a Call option at $900.
If the TSLA price does not rise above $900 before the Call expires, we will collect the full premium of the trade.
Now it's your turn to experiment with the tactics we shared today, and look for overvalued stocks to profit with a Call option.
If you would like us to analyse other popular stocks, please leave a message below.