Is That Stock Really Extended?
By Cliff Clark

How often do you come into the trading room and hear someone comment about how extended stock XYZ is and that they plan to short it, perhaps everyday? But what does extended actually mean when it comes to trading? Not knowing this can lead to subjective interpretations and faulty decision making. The term extended needs to be fully comprehended in order to take advantage of its implications and to avoid some of its pitfalls.

Let's first define the term. Here's a text book explanation.

Extended is a price condition which exists when the current price of a security has moved in a fluid and rapid manner during several time periods (relevant to any given chart) away from a "major" moving average (We'll use the 20ma for purposes of generalizing). This concept stems from the fundamental principle which states that a security on average usually can't move for more than 3 - 5 periods of time in any direction without having a contrary move taking place. In the context of a stage 2 uptrend, prices tend to move higher more than lower, and eventually will get away from their 20ma. This would be what anyone would call extended. But here is where many problems arise. Extended isn't a trading technique nor a pattern. In the context of a stage 2 uptrend, prices tend to be "extended" for long periods of time without a counter-move taking place. Vice versa for stage 4 downtrend. So shorting some security in a stage 2 just because it happens to be "extended" isn't a very wise choice, and this behavior will typically lead to large losses over time. To short something "extended" we still need a very defined pattern such as a climactic buy or sell setup.

As mentioned in the definition, extended is a fluid several bar move in one direction as opposed to a wide range bar move, which typically suggests a continuation.

Another characteristic of the term extended is that it should be analyzed in the context of the overall chart pattern. For example, a security that breaks out above a multi month consolidation and moves up for 3 - 5 green bars above such consolidation might seem extended but never pulls back. In this scenario, the extended nature of the move has to be considered in the grander scale of the overall pattern.

The point is, just because you think a stock is extended doesn't mean it has to pull back (or bounce). Before playing a stock that is extended whether long or short make sure you understand what extended means and how to play it. Playing “extended” stocks blindly will likely lead to large losses.