When facing complex markets, we are left with two choices. The first is to embrace complexity and, through a combination of financial model and rigorous study, attempt to comprehend what we face. The second approach is to simplify. As I explained in a recent weekly commentary, markets are complex adaptive systems that do not lend themselves to financial models and complete understanding. As an example, consider all the quantitative hedge funds that imploded based on events their models said would occur once every 10,000 years.
Instead, I prefer to simplify. When it comes to technical trades in my weekly newsletter EPIC Insights a simple approach is to invest with the trend. When markets were rebounding from the March lows, we were long. Now that they are reversing, we look to go short.
Considering the rally since March and subsequent pullback, we can easily find stocks that have violated uptrends and look to be breaking lower. However, in this environment that is not enough. With sharp rallies, we often face stocks that were traveling in parabolic uptrends that are well above their moving averages. When we see these stocks break lower it does us no good as the initial uptrend should not have been trusted and the distant moving averages indicate a stock that remains overbought. Instead, we look for consistent, long-lasting uptrends that have recently broken down and moving averages that will pressure the stock lower. While such strict criteria limit our universe, they increase our odds of success.
Such a search brings us to this week’s technical trade— Amazon.com (AMZN). As most stocks pushed to new lows in March, AMZN defied skeptics. Despite being a retailer reliant upon discretionary spending in a deepening recession, AMZN registered its lows in November 2008 and managed to rally 149% in less than five months. During the move, a steady uptrend (black line) guided the shares higher. When AMZN reported strong earnings, a gap higher established support (blue line) that has yet to be tested. While this was occurring, both the 10-day and 50-day moving averages (MA) lent credence to the belief that a steady accumulation was underway.
Over the past three weeks the tone has changed. Since topping on April 24, a downtrend (red line) has driven the shares lower and the stock now rests at a level below both the 10-day and 50-day MAs. Within this movement, the 10-day MA has started declining and is quickly approaching the 50-day MA. A popular trading technique known as the double-crossover involves selling shares when the shorter MA (in this case the 10-day) drops below the longer MA (the 50-day). Given the technical damage done, the crossover is quickly approaching and a powerful sell signal is days away.
With a downtrend in effect, the current price below the key MAs, and a crossover pending, AMZN presents itself as an excellent short sale candidate. Many investors have profits on positions accumulated over the prior months and should be taking gains as the market falters. Combine these factors and we should see a rush of sale orders over the coming weeks that will drive prices lower. I will position ahead of this move to earn the profits that will follow.
With a short bias, we turn toward price targets. The first line of support for AMZN will occur at the 200-day MA (currently $64.49). When that price falters, we should expect a test of support at $57.50. These targets present an expected gain between 11% and 22%. With such an expected gain, we will start small and add to the trade as proven correct. I recommend a short position in AMZN as this week’s technical trade.