Price Patterns - A Sudden Price Collapse Spells Disaster

One of the worst nightmares an investor can experience is the sudden collapse of a stock price. Usually the collapse is caused by unexpected bad news such as poorer than expected earnings, a downward revision of previously stated earnings, accounting errors or fraud, product recall, or indictments of key executives. Whatever the reason the stock price can tumble for one or more days and you can suddenly find yourself down thirty to sixty percent or more. Often the price decline happens so fast that you do not have a chance to sell before the damage is done.

Such a collapse happened on May 19, 2005 to the the stock of Able Laboratories (ABRX), a generic drug maker, after the company announced that it had temporarily suspended shipments of its products because of improper testing procedures. Chairman and Chief Executive Dhananjay G. Wadekar resigned two hours after the announcement. ABRX closed at $6.26 down 74.58% from the previous $24.63 close. Trading was very heavy as 31,346,100 shares (10 times the average daily volume) were bought and sold.

Then on Monday May 23 the company suspended manufacturing operations and recalled the rest of its products. The stock closed at $5.05 on volume of 25,425,400 shares. The stock continued down on heavy volume and made a short-term low on May 24 at $3.71.The price chart of daily closes shows the plunge.

A price collapse of this magnitude creates adversity for many investors but a few savvy ones can make money during the price decline. Investors with lots of nerve and some luck made from 14% to 42% profit by buying at $3.71 and selling at higher prices during the rebound off the low.

Percent Returns for All Buy and Sell Combinations

The percent returns chart shows the gains and losses for the daily buy and sell combinations from January 3, 2005 through June 8, 2005. The green areas represent the profitable returns and the red areas represent the unprofitable returns.

Before the collapse 79.6% of the buy and sell combinations (trades) made money. But after the collapse only 2.32% of the trades were profitable. The red wall shows the losing trades after the collapse. Prices declined so much that all of the previous buy prices were lower than the current prices after the collapse. The green peak in the left front of the chart represents the winning trades for the investors who bought at or near the $3.71 low.

Winners and Losers Map

The winners and losers map has no relief so it simply shows the profitable trades in green and the unprofitable trades in red.

The pre-collapse buy and sell combinations are to the left of the blue vertical line that delineates the pre-collapse and post-collapse trades. The post-collapse trades are to the left of the blue line. The long rectangle of red represents the losing trades after the collapse. The small green area in the lower right of the chart represents the few trades that made money after the $3.71 low was made.