Sometimes all we really need is a trendline to identify what to do with a stock.
One look at the chart of digital telecommunications product maker Qualcomm (Nasdaq: QCOM) tells us that the company has had a rough go for quite some time. And since trends tend to persist, this suggests continuing problems ahead.
Recent challenges include the still relatively strong U.S. dollar, issues with several licensees in China "improperly withholding" royalties on Qualcomm's patents, and bribery charges brought by the SEC.
But that has not discouraged fundamental analysts who point to the company's supposedly healthy free cash flow and its track record of raising dividends, with the most recent hike -- a 10% increase -- coming earlier this month.
I might add that the company's recent addition to a fledgling wearable technology index, WEARXT, is another good sign. But then why is the trend still so doggone negative?
In the battle between analyst and the market, I'll take the market every time.
Note: Right now, there are thousands of deposits being put down on QCOM by bullish speculators, hedge funds and even some average investors, all of whom are waiting for their orders to be filled. But three-quarters of them never will be and Wall Street will simply collect the money. That is, unless you get to it first.
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On the chart, we can see the two-year trendline still far above current trading. However, a tighter, 10-month line provides good resistance against the current advance. In fact, QCOM was down four of six trading days since reaching it on March 7. In plain English, QCOM is feeling the effects of overhead supply that presumably increased at the trendline.
To be sure, Qualcomm had a very nice run from its February low, gaining more than 25% through its March 7 high. That is a nice payday in anyone's book, but the technicals now show shares are tired and the rally looks to simply have been a reversion to the mean in a declining trend. That mean could be the 200-day arithmetically weighted moving average, which is running right through the trading of the past two weeks.
We have to remember that every change in trend to the upside starts with an extreme low. Unfortunately, we do not know if it is a corrective bounce or actual upside reversal until later. However, as a stock rallies we can look under the hood at momentum, volume and other structural technicals to build a case for one side or the other.
In QCOM's case, momentum indicators such as Moving Average Convergence Divergence (MACD) show the stock reaching an overbought condition this month. With the indicator scoring a downside crossover between its two component lines, we learned that sellers took over.
Daily traded volume shows a different view of a tired stock. During the entire rally, volume levels decreased to suggest waning participation in the move, which tells us demand was weak. In fact, the only real violation of this trend in volume happened on March 15, a day when the stock lost ground. This shows sellers getting more active.
As for chart structure, we've already seen how prices stalled at the trendline and moving average, but there is another resistance feature in play: The September low and December bounce both occurred in the current trading area.
The point is that if QCOM is going to fail, it is going to be in the current price zone. And from a trading perspective, if it is going to shake off its weak technicals, we should see a breakout soon. Therefore, setting a stop-loss just 5% above at $54 will ensure a minimal loss.
My downside target is $46.50, which is right in the middle of the November to February congestion zone, offering a potential 10% gain for an attractive 2:1 reward/risk trade setup.
Recommended Trade Setup:
-- Sell QCOM at the market price
-- Set stop-loss at $54
-- Set initial price target at $46.50 for a potential 10% gain in four weeks
This article was originally published on Profitable Trading: Struggling Tech Stock Offers 2:1 Reward/Risk Setup