Warning: This Popular Stock Appears To Be Headed For A Correction

Thursday, August 13, 2015 - 7:30am

by Michael Kahn

Although you could not tell from looking at the Dow Jones U.S. Restaurants & Bars Index, the group has had a rough time lately. From earnings bombs to reduced outlooks, there is something ugly happening beneath the surface. And that means the restaurant sector is a prime place to look for stocks about to crack.

To be sure, the index and some of the heavyweights in the group are still in rising trends, trading above their 50-day moving averages. But we do not have to look too hard to find stocks that are not quite as healthy. 

For instance, Chipotle Mexican Grill (NYSE: CMG), a market favorite for the past few years, looks ready to tumble.

From a fundamental perspective, we have to wonder why restaurant fortunes in general have not improved in recent months. Over the winter, the unusually cold weather was blamed. But as the days got warmer, sales did not heat up. And even as gasoline prices plummeted diners did not open their wallets any wider. 

On the sentiment front, poor action on good news is bearish. When things go wrong when there is every reason for them to go right we know that something deeper is going on in the market in question. 

Turning to the chart, Chipotle soared from below $600 in June to over $750 recently. That's a full-blown bull market in less than two months, and it left the stock in quite a precarious position. 

CMG Stock

Not only did it push momentum indicators such as the Relative Strength Index (RSI) into overbought territory, but it created an ominous expanding triangle pattern over the past year. 

An expanding triangle, or megaphone, pattern suggests increasing volatility and uncertainty as both bulls and bears take their turns pushing prices in their respective directions. Intra-pattern swings grow and the stock becomes unstable. 

It is one of the harder patterns to trade because its completion does not happen until the lower border is broken. That border is currently about 20% below current trading, so waiting would leave a huge move on the table. Therefore, we need to recognize the pattern but trade the swings within it.

The all-time high made in August happened on the upper border where a low-risk short could have been opened. The problem is that the term "low risk" refers to the concept that the stop point is very close and losses would be small. But the real risk comes from the lack of confirmation that resistance at the upper border will hold, and the probability that it may not is somewhat higher. 

Ideally, we'd wait for the upper border to be tested one more time and then see the stock move under the short-term trading range created by that move. However, there is no guarantee that there will be a test of resistance. While selling CMG short now is higher risk, it offers higher reward -- more than 20% before the megaphone pattern is even completed.

I'll take the bearish sentiment condition, the rather high fundamental valuation and technically overbought conditions as a decent risk for short selling. 

If you're still leery of shorting, especially given the high price of CMG shares, there is a way to put up a fraction of the cost and multiply your profits several times over. And I'm not talking about selling short on margin, which only increases your risk.

Instead, just last month, a simple strategy landed traders a 2,036% annualized return on a sell-off in a popular ETF and a 2,797% profit on a drop in a much-hyped stock -- all while risking just over $1,000 combined. To learn how you could use it with CMG or any other stock on the verge of a decline, follow this link.

Recommended Trade Setup:

-- Sell CMG short at the market price
-- Set stop-loss at $765
-- Set initial price target at $590 for a potential 21% gain in 10 weeks

This article was originally published on ProfitableTrading.com: Warning: This Beloved Stock Appears Headed for a Bear Market

Michael Kahn does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.