Introduction

The world of stock market investing is a dynamic landscape, full of opportunities and challenges. The price of stocks fluctuates every day. As investors, we may not give that much importance to single-day price changes. But as informed investors, we should look at wider price patterns for better entry and exits. So, in this blog, we will discuss one such pattern that can generate non-linear returns if you exit at the right time or can trap you if you enter at the wrong time. And the phenomenon that demands attention is the "climax move".

We will explore what climax moves are, how they manifest due to supply and demand dynamics, the potential pitfalls for investors, and essential strategies to navigate and avoid these traps.

What is a Climax Move?

A climax move is characterized by a sudden and often extreme price shift in a stock. These rapid movements, whether upward or downward, stand out from the typical fluctuations in a stock's price. Recognizing climax moves is crucial for investors as they can signal significant shifts in market sentiment.

We will look at some examples in more detail in the second half of the blog.

How Climax Moves Occur: Supply and Demand Dynamics

Understanding climax moves necessitates insight into the fundamental forces of supply and demand. These moves often result from a sudden imbalance in buying or selling pressure, causing prices to soar or plummet.

There can be multiple factors that lead to this kind of move. We have mentioned some of them here.

News and Events: Major news announcements or events can spark immediate and extreme reactions in the market.
Technical Breakouts: Breakouts from key technical levels can attract a surge in trading activity.
Market Sentiment Shifts: Rapid changes in investor sentiment can trigger intense buying or selling.

Let’s understand the investor psychology behind any climax move. Take an example of a climax move in a positive direction. What generally happens is a stock starts its upward journey due to a fundamental or technical trigger. It can be anything from a positive surprise to a fundamental improvement in business. Many investors miss entry at lower levels and they wait for the stock to correct. And if stock prices do not come down or continue to rise, after a certain point in time Fear of Missing Out (FOMO) kicks in.

Due to this FOMO, investors rush to buy the stock creating a huge demand for the stock. This in turn leads to irrational price moves in the stock. This trend continues till the last bit of momentum is sucked out of the stock.

What happens afterwards? A sustained period of pain in case of a bullish climax move. Stock price generally falls rapidly and does not move for an extended period.

How to Identify Climax Moves?

Climax moves are generally clearly visible on the charts. You can see the sudden price rise with increasing volumes. The price increases continuously for days and leads to a parabolic move on the charts. Even though overall volumes are huge, delivery volumes are low during this period as stock prices go up due to a very high amount of speculative trading.

Investors can use various technical indicators, such as volume spikes, relative strength index (RSI), and moving averages, to identify potential climax moves. These tools provide insights into the intensity and sustainability of the price movements. For example, if a stock moves higher and trades at a 50-60% premium to its 21-day EMA, then it is time to be cautious.

In most cases, at the end of a climax move, the price goes up and drops drastically with very high volume. This volume is generally higher than all the previous daily volumes during the climax move. And this is an indication that the last drop of momentum is sucked out and the price movers have decided to go away from this counter. Getting too complicated? Let’s understand this with real examples.

Examples of Climax Moves

Let’s look at two examples from the Indian stock market to understand the climax move.

Example 1: IEX

During the post-COVID rally, we saw a climax move in IEX during the Sep-Nov 2022 period. Below is the daily chart of the same.

Here you can see the sudden rise in volumes in the September month and then the price moves parabolically on the chart. At the end of this move, the price drops drastically with very high volumes. We have highlighted this with a blue arrow.

The price may rise immediately after this move, but volumes will be lower. And then comes the painful period for investors who have bought during the up move as the price goes down and down. As you can see, the current price is around Rs. 145.25 (highlighted in black).

Example 2: IRCTC

IRCTC also saw a climax move during the same period. Here is the chart.

As you can see, volumes rise and the price makes a parabolic move before falling with a huge volume (highlighted by an arrow). What comes next is a painful period of stock price not moving for months. The current price is still lower than the peak made during the climax move.

Potential Traps for Investors

While climax moves present an opportunity for non-linear returns in the very short term, they generally pose significant risks for investors and trap them. Below are the most common mistakes that retail investors make during a climax move.

Emotional Reactions

Investors often fall prey to emotional reactions during climax moves. Behavioural biases kick in. FOMO (fear of missing out) may drive them to buy at the peak, or panic may lead to hasty selling at the trough.

Ignoring Risk Management

Failing to set a hard stop-loss or establish a risk management strategy. For stop loss during a climax move, you can use simple indicators like moving averages. You may exit when the price breaches a short-term moving average like 10 EMA.

For example, your stop loss would have triggered at around Rs. 1000 using the 10-day EMA as a stop loss during the climax move in IRCTC (the orange line is a 10-EMA).

As we are in the bull market, we are also seeing parabolic moves in many names. Identify those names and be very cautious if you have already invested in any of them.

How to Avoid Falling into the Climax Move Trap?

Protecting yourself from the risks associated with climax moves requires a disciplined and informed approach.

Establishing a Solid Risk Management Strategy

Define your risk tolerance and set clear stop-loss orders. Diversify your portfolio to spread risk and avoid overexposure to a single asset. Use data-driven tools and indicators to strengthen your judgement. For example, you can use the value score on sharpely to gauge the current valuation levels of a stock going through climax moves.

Setting Clear Entry and Exit Points

Have a well-defined trading plan. Determine entry and exit points based on thorough analysis and stick to your strategy even in the face of emotional impulses.

Conclusion

Climax move is a widely seen phenomenon in the stock market especially during the bullish times. Understanding them is crucial for investors aiming for long-term success as it can help generate non-linear returns if you act correctly. But it can trap you and wipe your money if you become emotional and enter at the wrong time.

By recognizing the signs, avoiding common traps, and leveraging tools like those offered by sharpely, investors can navigate climax moves and make informed decisions.