The mistake traders made in TSLA

Free After-Hours Analysis:

I normally let more time pass before writing about a company again in these free blog posts, but TSLA’s price action has been dramatic enough to warrant a second post. After surging 10% in a single day, I told readers earlier this week, “it would be both foolish and reckless to chase the stock at these levels.” And wouldn’t you know it, in less than three days the stock gave back all of those gains when it opened this morning.

Now I want to be clear, I am in no way a TSLA bear and am most definitely not calling Tuesday a top. But I do know the market and radical surges like TSLA experienced over the last few weeks are most definitely not sustainable. This was a frenzy of breakout buying and short-covering, not systematic, rational, and sustainable buying.

Momentum traders and shorts losing money were jumping over each other trying to buy this stock before it went any higher. But the thing to remember about breakout buying and short-covering is both of these groups are not buying the company for fundamental reasons. They are chasing momentum. And more than just that, both groups of buyers don’t have a lot of money. They quickly move all-in (or all-out in the shorts’ case) and then they’re out of money. Once they trade, their opinion stops mattering and the wave of buying that fueled the explosive breakout evaporates.

This implosion of demand is further compounded by institutional investors’ aversion to chasing prices higher. Even if they like the company, they know these surges fizzle and they will be able to buy at cheaper prices if they are patient. And in a bit of a self-fulfilling prophecy, when institutional investors wait for lower prices, that creates a lack of demand and prices fall.

So if chasing prices higher Monday and Tuesday was a mistake, what was the right way to trade this? If we wanted to buy the breakout or cover our shorts, we should have done this long before the move became obvious to everyone. In this case, when TSLA initially broke through the old highs near $390. Buying at this point allows us to get in early and more than just that, it gives us a sensible stop near current prices that will limit our losses if we are wrong. And rather than recklessly chasing prices higher earlier this week, we would have been cashing in our profits and looking for the next trade.

As for what’s next, I like the way the stock bounced back today, but I need to see more to be sure. Maybe I will write about this stock again in a few days after it gives us more information about its intentions.

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Tags: S&P 500 Nasdaq $SPY $SPX $QQQ $IWM $TSLA