By Dr. Alexander Elder and Kerry Lovvorn
A parabolic rally marks the terminal stage of a bullish trend. Every rally in history that went parabolic ended in a drastic drop. Many have never reclaimed the heights of their glory days. Crowds pour their money into parabolic moves, but when the gravity kicks in and the love affair ends, bag holders are hurt and disgusted by horrendous down moves.
To recognize parabolic rallies and to profit from them, we use a clearly defined set of technical rules. A parabolic rally has three parameters:
- Two closes outside of a three-standard deviation channel of a 24-month Average True Range (ATR).
- Five-month moving average is within 20% of the three standard deviation of the 24 month ATR (monthly 3-ATR channel).
- Minimum drawdown from high to close is less than 15% in the past six months.
When a market moves outside of its monthly 3-ATR channel for two consecutive months, the monthly 5MA is within 20% of the 3ATR and it has not experienced a closing drawdown of more than 15% in the past six months, we consider this a parabolic move.
A market that goes parabolic does not have to crash immediately. A parabolic move can persist beyond any logical measure, but the longer it lasts, the more vicious the subsequent crash. Let's review several examples.
This chart shows a parabolic move in crude oil in 2008. Oil closed outside its monthly 3ATR for the second time on June 2008. Goldman Sachs predicted that oil would hit $200 per barrel, and many market participants believed oil could only go up.
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Oil topped out the following month. The move back into the 3-ATR channel and subsequent break of the monthly 5-MA sent oil crashing.
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This chart shows the tech bubble that went parabolic in 2000. Everyone "knew" that the tech stocks could only go up, and there was a mad rush into their shares.
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In April 2000 the Nasdaq bubble popped, and the tech-heavy index never reclaimed its glory days' peak. 
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Last year we saw silver stage a parabolic rally. In April 2011, silver closed above the monthly 3ATR for the third consecutive month. Many thought the metal could do nothing but levitate, with the talk of a $100/oz target.
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The following month saw the top in silver, as it moved back into the 3ATR channel and closed below its 5MA. The highs of that year have not been seen again.
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Apple had a parabolic rise in March 2000, during the tech bubble days. It closed outside the 3ATR channel for 6 consecutive months.
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Once Apple pulled back into its 3ATR channel and crossed below the 5MA, it went into a severe decline. It did not make new highs until 2005, nearly five years later.
Most stocks that stage parabolic moves never recover their glory day highs. Their list is long: Cisco CSCO +0.65% (March 2000), Yahoo YHOO +0.50% (December 1999), Oracle ORCL +1.28% (August 2000). Futures also tend to sink below their parabolic tops for years if not decades: for example, sugar since January 2006 and copper since May 2006.
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Apple, nevertheless, had another parabolic move in 2007. By December of that year it closed outside of its 3-ATR channel for 8 consecutive months.
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The following month Apple moved back inside its 3ATR channel and closes below its 5MA. It did not reclaim its previous highs for another 10 months. Apple has been one stock to demonstrate it could move into multiple parabolic moves.
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Today, Apple is on a tear again. It has not seen a drawdown of more than 15% on a closing basis for over 37 months. It has closed outside its 3-ATR for two months in a row and is now in its third consecutive month above the rising channel. A growing number of analysts are setting the $1,000 price target, which would make Apple the first trillion-dollar stock in history.
Can Apple continue to rise in this parabolic manner? Anything can happen in the markets, but we have our numbers ready. If Apple begins to falter and moves out of its parabolic state, its selloff will be ugly. Most folks believe Apple can do no wrong. It is a dangerous stock to hold for which nothing less than perfection is expected. Parabolic moves are unhealthy and always end badly.
While we were working on this article, we received a call from a friend. She got married in February and received ten shares of Apple. Her gift was worth $5,000 on the day of her wedding, but it is over $6,000 today. She wanted to sell all her stocks and buy more Apple. We told her instead to put a protective stop well above $500 per share to protect her gift. She did not know what a stop was, fairly typical of the folks who pile into a parabolic move.
Disclosure: Dr. Elder is short Apple.
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