What is a Blow-Off Top?

In a vacuum, a blow-off top is a steep increase in volatility, volume, and rate of price change which ultimately leads to a collapse in the opposite direction.

On a chart, the price pattern often resembles a cone. It steeply increases, reaches an extreme high, then steeply decreases, with the ultimate high of the move being the cone’s peak. 

Here’s a roughly drawn example of the “cone” idea in Microsoft Paint. This is just illustrative and isn’t meant to be an accurate representation of what your typical blow-off top looks like:

These are some of the most troublesome moves to deal with, whether you’re on the right or wrong side of the trend, or even if you’re just tracking the market and trying to initiate a favorable position.

Liquidity is scarce, and the market can move significantly against you or in your favor before you can populate an order ticket. Day trading these moves is not for the point-and-click trader. 

Some traders specialize in this type of trading.

They have nerves of steel, can withstand their position going significantly against them before the tide turns, and most of all, the successful ones size their position very conservatively.

They know well how rapidly these moves can be, how much slippage they can experience, and account for uncontrollable variables like trading halts. 

But most traders aren’t apt for this type of trading. It’s exciting to be on the right side and devastating to be on the wrong side.

A successful trading plan around these moves is possible but is more than just having a mechanical set of rules. It takes that unquantifiable intuition, lots of experience, a powerful trading mindset, and a certain temperament.

For that reason, this article won’t focus on how to trade these types of setups but instead describe them and provide context where possible.

The Problem With Identifying Blow-Off Tops

The problem with blow-off tops is that they’re usually only visible in hindsight.

Trying to fade a move because it looks like a potential blow-off top is one of the most dangerous trades you can possibly take, as liquidity is extinct amidst these high volatility times–the bid/ask spread is significantly altering every millisecond.

By the time your order reaches the exchange, chances are, the price has moved against you, and you have to reprice your order.

Sending a market order is bound to lead to horrifying slippage, which might not be accounted for in the trade’s intended risk.

Our mind can work against us when recognizing a pattern like a blow-off top, where we distinctly remember all of the situations where the pattern worked, leading to an imminent decline in the stock, but we hardly notice when the signs are there, but the pattern fails.

These sort of mental biases can lead traders to take outsized positions against an extreme trend, playing for a blow-off top, only to blow up their accounts. 

That’s not to say that there’s no value in knowing and analyzing this pattern.

After all, you might be on the right side of a runaway trend and get puzzled on where to exit. When these types of moves happen, few, if any, support or resistance levels or any sort of symmetrical technical analysis patterns could give us clues.

Many traders have been long hot assets like crypto or cannabis stocks and freeze up when everything is going right for them, and the price is going “to the moon.”

If you’re fortunate enough to find yourself in this situation, it’ll help immensely to know places where it makes sense to reduce risk. 

Example of a Blow-Off Top

The classic example of a blow-off top is the 2017 Bitcoin bull market. Let’s break down the chart and explain what happened to provide some context to the price action that led up to the blow-off top.

What do we see here?

First off, a powerful long-term uptrend leading up to the top. The market was strong, and the upswings were generally far stronger than the pullbacks. As time passed and the trend continued, the momentum increased.

The ranges of bars got wider, and the shadows of the candlesticks got larger. 

We see a definitive change in character around December 2017. See the area marked “A” on the chart. The market made two huge moves to the upside, registering price changes several multiples of the average day’s range prior.

You can see this register on the Average True Range indicator at the bottom of the chart. Most traders using trendlines probably saw them significantly breached at this time; the rate of price change accelerated to an extreme. 

We should think about what a trendline really tells us: the rate of change over time.

If you extend a trendline out far into the future, it’s clear that the current trend cannot sustain this level of growth far into the future. So the question becomes: where and when is the turning point? 

On those first two days marked “A,” the bulls were firmly in control. The market moved directionally, low-to-high, on the first day and closed in the upper 50% of its range on the second day. 

The trend shifted character once again following that, with the market struggling to make new highs.

Think about what some traders might be thinking and doing in this area. Many are buying the breakout of the high, shorts are placing their buy stops a few ticks above the previous high, and the new buyers who got in near the high are using the swing high as their anchor–if the price fails there, they plan to rush for the exit. 

Which is why price action around the extremes in these moves is so important. It’s where the most activity typically occurs and where the stops are clustered.

The area marked by the red arrow shows a failure at the high, but there’s not significant selling away from the level until a few days pass. Intraday, there is a sense of balance. The market is whipsawing a lot but going virtually nowhere.

As it becomes clear to traders that a significant new high isn’t coming yet, many of the short-term buyers are rushing for the exits, shorts are adding to their positions, and the intermediate-term position traders are taking some profits.

When the market fails to break the downtrend on significant momentum in early January 2018, the market settles into a downtrend as the mania dies down. 

The Psychology of Blow-Off Tops

The price action in blow-off tops reaches far outside any price bands or trendlines. The moves are often erratic and hard to make heads or tails of. A look into the intraday price action usually presents us a whipsaw.

Tons of short-lived trends, both with-trend and counter-trend–usually, the 3-minute charts will look like a series of Vs or Ws.

If we draw a new trendline and extrapolate it into the future, it tells us that the market will increase by more than tenfold by the end of the year. It becomes clear that this can’t last, but nobody knows the turning point. 

For a price move like this to even sustain, let alone continue aggressively upward, new buyers need to enter the market.

Many are already aggressively long on margin and can’t continue buying. These new buyers need to make money. Because many of the new buyers in these types of moves are novice traders, they’re usually quick to sell at the worst time if they’re losing money.

When their selling pushes the market down, the earlier longs start taking profits as they see their P&L declining. This type of cascade even forces out some of the “strong-handed” position traders who have been long this trend for several months or weeks. 

What little technical structure there is in these moves could represent meaningful turning points. These levels are typically easy to identify–the extreme high and low–but difficult and potentially disastrous to execute upon. 

Things To Watch Out For

• Failure to breach the extreme high of the move
• Bearish price action right near the significant high of the move
• Momentum divergences on new highs. Remember, to sustain such a monster price move, these trends need a stream of new buyers. A momentum divergence suggests that the pool of buyers is thinning out

Bottom Line

If you look around in the February 2021 markets, there are potential and confirmed blow-off tops everywhere.

If this roaring bull market continues, there will continue to many of them. In most of these situations, there aren’t that many trading opportunities for most traders.

If you have a toolbox of patterns you strictly trade, there could be a tendency for FOMO (fear of missing out) to try and fit your pattern to justify a trade in these markets. We all know that this is a recipe for failure in the end.

Regardless of your thoughts on Jim Cramer, I like his slogan “there’s always a bull market somewhere,” if you accept this premise, there’s no need to force trades in extreme trends.

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