Stronger-than-expected earnings sent shares of Microsoft (Nasdaq: MSFT) soaring in October, scoring a very significant upside breakout on the charts. Since the August lows, when the market as a whole tumbled, this stock is up nearly 40%, putting it in an elite group of large caps that enjoyed big runs in 2015.
Sentiment was rather hot, especially after the October jump, but the blue-chip stock has only added about 3 points to its total since then. Indeed, most of the big-cap leaders have not done much since that time. Most sectors are now in decline, leaving leaders without any followers -- a condition that cannot last forever.
As a result, I am watching for signs that the leaders are starting to roll over -- and I see those signs in Microsoft.
I will say this is quite a contrary point of view as sentiment is still positive, though not extremely so. Pundits are still calling Microsoft a good buy, and even trader consensus on social media is very much in its camp.
To understand my bearish case, let's start with the big picture. The weekly chart shows current levels are only about 8% away from the 2000 technology bubble high. That may sound like a lot, but in the context of the entire span of time when Microsoft lost 75% of its value from peak to trough, it is quite small.
In fact, the stock has now regained 90% of what it lost, and in the investment world, those last few percentage points can be the most expensive. The risk of loss should it fail to reach its goal is large compared to the gains that would come from squeezing out those last few points.
Furthermore, Bollinger Band analysis shows additional risk. When a stock trades above the bands, it is exhibiting strength. However, if it trades above the bands in a rally and then makes a higher high back within them, is a sign of waning momentum. That is the current state of this stock.
There is an alternate analysis that suggests the stock has a few points of upside left, but not quite enough to reach its 2000 high water mark. A simple measurement of the mid-2014 to late 2015 trading range points to a target in the $58.50 area, just shy of the $59.97 all-time high. We get this target by projecting the pattern height up from the breakout price. Right now, Microsoft is about halfway to that objective.
The problem is that stocks in the middle of support and resistance, the latter supplied by the price objective, are in no man's land. The risk/reward for both longs and shorts is not good enough to initiate a trade. That's why my strategy here is split.
We should either wait for the upside target to be reached and then sell, or for the current upward sloping trading range to break to the downside and sell there.
The next chart will show why I lean more toward selling than buying, aside from the overall narrowness of the broader market.
It is a simple matter of short-term indicators. Since October, momentum indicators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD) and stochastics all sport bearish divergences with price action. Also, the spread above moving averages is contracting, and on-balance volume failed to set a higher high with price.
We can even argue that last week, when price hit its high for the current rally, it ended that day with a bearish reversal bar. That signaled a rejection of the new high -- an additional warning.
Therefore, the sellable breakdown would occur with a move below the rising channel's lower border, which equates to a price below the Dec. 18 close of $54.13.
I'd rather sell a bit early than get trapped in the stampede to the exit doors. When weekly charts show a strong ceiling above and short-term signs of weakness are everywhere, the risk/reward for owning the stock is not to my liking -- but shorting the shares is.
Recommended Trade Setups:
-- Sell MSFT short at $58.50
-- Set stop-loss at $61
-- Set initial price target at $49 for a potential 16% gain in six weeks
-- Sell MSFT short at $54
-- Set stop-loss at $56.50
-- Set initial price target at $49 for a potential 9% gain in four weeks
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This article was originally published on ProfitableTrading.com: Pundits Say This Blue Chip is a 'Buy,' but the Charts Say, 'Sell'