Networking stocks looking weak. Expectations for corporate spending being revised lower, and charts are breaking down. More here: Networking Stocks: Ready to Short?
Numerous traders decided to go long AAPL this morning on the strength of the big reversal bar. For the sake of mental clarity, I wanted to write out why I didn't like the AAPL reversal bar -- the one on 4/17. The setup got me thinking more about what goes into the context of a good setup and what doesn't (from the way I view things). Some thoughts: Setups are like poker hands. At the poker table, position matters a lot. A reversal bar could be compared to JTs (Jack Ten suited). Whereas you might fold JTs under the gun, you would most likely play it on the button. The difference is position. Position matters -- in trading as in poker, the setup can't be taken in isolation. Volatility expansion is a warning sign. AAPL's large drop represented a major volatility expansion, and break of the 20 EMA, relative to a quiet uptrend with no 20 violations that had lasted for all of 2012. That break says something different is happening here. Group context: Other speculative vehicles did not confirm AAPL's reversal. If a bunch of other hard-hit names like GOOG and PCLN had turned around too, or if speculative names in general had gotten a big pop, that would be one thing. But AAPL turned alone, giving greater weight to the possibility of an anomaly. Fundamental context: The whole fund management universe is long AAPL. At this point, are all those long hedge and mutual fund managers thinking "Oh boy lots more upside for AAPL, better buy even more on this strong reversal bar?" Or are they thinking "Gee, I overweighted this thing like hell already (and so did all my colleagues)... maybe I shouldn't be so greedy up here, and lighten up on the gift of a reversal after that stomach-churning warning drop." Sentiment context: AAPL sentiment had already reached a hyper-extreme. A couple days back some jokers were calling for an AAPL trillion dollar market cap and no one laughed. The presence of hyper-bullishness already built into the stock decreases the odds that the reversal would turn into a meaningful catalyst for blowoff upside. To sum up, the greater the number of conditional probabilities -- small edges -- you have in your favor, the better, and trades are like poker hands in this regard: The "setup," especially when it is as thin as a single bar, should be validated or invalidated (taken or passed) based on surrounding factors (much as certain poker hands are either played or not played depending on multiple elements of situational context).
I'd just like to chip in on AAPL, as someone who has been long for the last couple of years, both for fundamental and technical reasons. I'll list the pros and cons, fundamentally and from a technical perspective: 1. AAPL is not as cheap as it used to be - at times it was trading at less than 10 times forward earnings estimates, once you stripped out the cash horde. But it is still quite cheap. 2012 earnings estimates are 44 on average, with a low estimate of 41. Let's be conservative and take the low estimate. AAPL has about $70bn in net cash also. So, at 590, that puts it on about 12-13 times ex-cash earnings per share - cheaper than the overall market. Estimates of AAPL's long-term growth rate are about 18% per annum, putting it on a long-term PEG of about 2/3. That is cheap by any standard. 2. The upside fundamentally is less - it's harder to grow as fast at such a huge market cap and you run into the law of large numbers. However, all the products are by all accounts growing quickly. There is enormous expansion possibility from the BRIC countries, China has relatively low penetration for example, same with India. 3. Europe's woes might make earnings come in a little on the light side this quarter. So, fundamentally it is quite straightforward - there's some short-term mild earnings risk, but the long-term perspective is still very bullish and the stock is still cheap. It is at a lower PE than the market, for a business that is growing faster than the market, that has a far superior balance sheet to the market, and a much more attractive business franchise and management than the average. Fundamentally it is a no brainer, just as it has been since the 2008 crash. However, it is not as much of a no brainer as it was in 2011, 2010, or 2009. Technicals: 1. AAPL has gone up a hell of a lot in a fairly short time. It is still, even after the recent selloff, massively above its 200 day moving average, and it reached a peak of around 16.5x ATR (20 day average true range) above the 200 day MA. That is historically very overbought. As a comparison, in 2000 at the peak, the nasdaq was 14.2x ATR (20) above the 200 day MA, and that was one of the most insane bubbles of all time. Other market peaks were things like oil 2008, or housing stocks in 2006, and my studies showed that about 12-14xATR above the 200 day MA is usually a time of serious risk after a lengthy and sizeable bull run. 2. After several years of trading stronger than the overall market - going down less in selloffs, grinding higher in trading ranges, and rallying harder when the overall market is up - the relative strength has now gone into reverse. In the last week or so, AAPL has now started trading weak relative to the overall market. 3. The chart pattern of a rising trading range, followed by a huge uptrend, then a sharp reversal, followed by a failed retest attempt of the high, is a classic topping pattern and warning signal for a potential trend reversal. The quick move from 644 to 572, followed by the 1.5 day rebound to 620 which rapidly failed, fits this pattern. A breakdown below the recent pullback low would confirm this and indicate a potential new downtrend in the short-term. 4. Sentiment has gone from sceptical or neutral back in the 200s and 300s, to significantly bullish now. There is no doubt that it has become a rather crowded trade. I know one guy who has his entire net worth (several million) in AAPL, and his response to the recent selloff was that it's just a blip on the run to $1000 and beyond. He may well be right, but his complacency is a bad sign from a trading perspective. When you get a very overextended trend, weakening momentum and relative underperformance (after a long period of outperformance), a chart patten indicating a potential trend downturn, and all this in the face of a very bullish speculative sentiment, it means at the very least the risk is rather elevated. So to me, the technical picture is quite bearish and if this was just stock XYZ instead of AAPL I would view it as a potential trading short. Only the upcoming earnings, and the fact we have not yet broken the pullback low at 572, would make me wary of taking a short position. My overall assessment then is that AAPL is still a cheap stock, but that it is a risky long from a trading perspective. Historically, the right position to have on in those situations is a normal long investment position, hedged against short-term downside. I have therefore recently cut my own position (which was very large) by 2/3 and hedged the remainder with some front-month puts. I would consider buying back if there is a significant further decline and panic low, if the stock got very cheap indeed (e.g. 500 or lower), if earnings are a real blowout, or if the stock starts to display bullish price action again. Hopefully that gives some insight into the trading process, and the current chart action, for someone involved in the stock.