How To Trade The Looming Bear Market In Tech Stocks
I have not been a fan of the technology sector for the past month and even penned a missive calling “tech leadership an illusion.” While superstars such as Google (Nasdaq: GOOGL) were soaring, the rank-and-file tech stocks were actually lagging the market.
Semiconductors have been some of the worst offenders. The benchmark PHLX Semiconductor (SOX) index actually started to fall in late May and has already sunk back to levels last seen in October.
There is an old bit of Wall Street wisdom that says to buy the strongest stocks in the strongest groups. This is based on the concept of relative strength. Research has shown that outperforming stocks tend to continue doing so. Conversely, the weakest stocks in the weakest sectors are likely to keep falling.
One especially weak stock I have identified in the weak semiconductor sector is Linear Technology (Nasdaq: LLTC), a designer and manufacturer of analog integrated circuits used in power management and signal conditioning.
An earnings miss in July sparked a high-volume gap down, with shares opening 7.2% lower the next day.
Considering the stock was already down 10% from its June high, that drop was a big deal. Of course, bottom fishers noticed the “correction-sized” decline and came in to buy what they thought were cheap shares. The stock rallied back to the pre-gap price on mostly declining volume, but then failed as shares also went ex-dividend.
Gaps, or areas on the chart where supply and demand are so out of balance that prices have to jump from one level to the next, often create future support or resistance. In this case, it was resistance — and it was strong.
In another sign of weakness, LLTC managed a small bounce on Aug. 12 — the day the broader market fell by a huge amount in the morning only to power back to a net gain on the day — but still closed down slightly. While the major indices managed a few days of gains, Linear Technology immediately moved lower again, bolstering the bears’ case.
Some chart watchers will point out that there is support in the $39 to $40 area from the October low and other turning points going back to the early part of the previous decade. However, I see it differently.
The stock is now below the bull market trendline originating at the 2008 low and running through the major correction of 2011. And the weekly chart shows a potential massive double-top over the past two years. If broken to the downside, it could lead to steep losses.
How far could LLTC fall? The measuring technique I often use is projecting the height of the double-top pattern down from the break point. But that seems to be a bit too severe even for a bear market, at least on the initial forecast.
Another method is to use Fibonacci retracements. A serious correction is often thought to target the 61.8% retracement of a bull run. Starting at the 2008 bear market low, that would take shares down to the $31 area, 23% below the current price.
Such predictions can be flimsy, but seeing a retracement from a different starting point at that same target level creates a more compelling story. Starting at the 2011 low, the 78.6% retracement is also in the $31 area.
Of course, it is possible to put enough Fibonacci lines on a chart to make it say whatever you want. That is why I never go any deeper than 78.6%. For you math wonks, 78.6%, or 0.786, is the square root of 0.618 — the Fibonacci golden ratio.
This is a level that often acts as the point of no return. In my experience, a drop below 78.6% usually leads to a full 100% retracement.
Indeed, there is regular chart support in that area to further reinforce this bold call. And with the July-to-August rebound forming not only a test of the July gap, but also the breakdown below the 2008 trendline, there is ample reason to sell now. I also have enough confidence to use a wide stop-loss with this volatile stock.
Recommended Trade Setup:
— Sell LLTC short at the market price
— Set stop-loss at $43.50
— Set initial price target at $31 for a potential 23% gain in four months
A 23% gain in four months is certainly nothing to scoff at, but certain traders have made even bigger profits on falling stocks in a shorter amount of time:
— A 33.9% profit on Keurig Green Mountain (Nasdaq: GMCR) in 56 days
— A 40.4% profit on Yelp (NYSE: YELP) in 29 days
— A 30.4% profit on Wynn Resorts (Nasdaq: WYNN) in nine days
— A 40.5% profit on Dillard’s (NYSE: DDS) in seven days
— A 69% profit on Alibaba Group Holding (NYSE: BABA) in nine days
And each of these gains came on a significantly smaller down move in the underlying stock. Find out who is making trades like this and get the chance to try the next few trades risk free by clicking here.
This article was originally posted on ProfitableTrading.com: Tech Stock’s Correction is About to Become a Full-Blown Bear Market