When Small Cues Add Up

Today I want to highlight the importance of being aware of technical cues that can play a role in anyone’s risk management process, regardless of their time-frame. Use of TA is essential if you’re an active manager or trader because it introduces risk management to your process and allows you to manage entries and exits more effectively. This does not mean that with technical analysis we suddenly have a crystal ball that allows us to top and bottom tick every exit and entry, but it does allow us to notice when conditions are changing and more importantly, when the risk/reward is no longer in our favor.

I want to use the example of LinkedIn because the stock sold off significantly on Monday and has remained relatively weak since. As the chart caption states, my stance on LinkedIn changed significantly, at least for the short term, on 9/11/14 because of a few key factors.

LNKD

On September 11th, I noted that the risk/reward in LinkedIn was changing and that it was a good opportunity to clean up longs or try a short as the risk on the short side became clearly defined.


Now lets look at the facts that presented themselves on that day to put things into perspective and explain why I made this note.

1. Look Where We Came FromAs of 9/11/14 LNKD was up roughly 70% off its YTD lows and that change occured in just 4 months.

2. Mean Reversion: Using the opening price on 9/11/14 of 229.54 and the 50 day SMA of 197.42, we can see that price was roughly 16% above its intermediate term trend. Eventually price will revert toward its mean, or average, either through consolidation or a pullback. I know the word “eventually” adds no value, but historically, a stock extended this far above its trends smoothing mechanism will have a tough time continuing to the upside without some consolidation.

3. Fibonacci Retracement Level: Fibonacci retracement levels, in this case the 78.6% retracement from the all time intraday high of $257.56 to the intraday 2014 low of 135.94, can prove to be important levels where the security might see some resistance. In this case, price tested that level 6 days before finally being rejected and breaking to the downside.

4. Momentum: Clearly momentum is both overbought and showing a negative divergence, not confirming new highs in price, which is concerning as we head into resistance.

5. Broken Short-Term Trend: The 11th was the first “potent” down day for LNKD since we approached the resistance level mentioned above. What I mean by this is that we saw range expansion, a break of a 1 month trend line support and the ability of sellers to close price near the lows of the day, which they hadn’t been able to do in the few days prior.

Takeaway: The takeaway, or at least my takeaway from this exercise was that on 9/11/14 I saw no reason to be initiating or adding to a long position in LNKD and would even be trimming the position if my time-frame permitted. Also, the risk was clearly defined on the short side therefore if you were looking for a short entry, you got it against the highs of the day or the week depending on your time-frame. Nobody knows where the stock will go from that entry, but it is important that the risk/reward is defined and you took action on your position because conditions changed notably.

Result: The result was that in just a few trading days, we are now roughly 20 handles lower in the stock and you could’ve saved some money or made some money on the short side by taking notice of a few small cues. I’m sure there are a few other factors that contributed to this, but these are the main ones I saw that changed my stance on the stock last week.

LNKD 1

Just goes to show that you never know where a stock is headed for sure, but if you have a process that helps identify small changes in the trend, you can save yourself a lot of pain in the process.

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