Chart Pattern Warning of a Breakdown That Could Deliver Fast Profits
Hardwood flooring specialty retailer Lumber Liquidators Holdings (NYSE: LL) has rallied about 30% year-to-date. The slope of the rally has now become excessively steep just as the stock is bumping into the upper end of its two-year trading channel.
A weak daily close on Tuesday, March 26, coupled with negative divergence between price and momentum, further limits the intermediate-term upside in the stock.
The weekly chart displays the multi-year move higher in LL shares. In early 2009, it traded down into the low $7 range, but then tore higher, making it into the low $30s just one year later.
Following that strong move off the broader market bottom, LL slipped into a pattern of weakness that didn't come to an end until early 2012. The stock then started to come back to life as homebuilding stocks began to break higher out of bullish patterns.
The break of a meaningful, multi-year resistance line in early March finally kicked off a major bull move in LL shares. For swing traders, the move up was pure joy to trade as pullbacks to simple moving averages were getting bought -- a real sign of strength.
Ultimately, however, as the stock continued to extend both in time and slope, signs of fatigue began to show.
By many measures, the stock's upside momentum peaked in early February, as it was also hitting its price highs for the month. The late-February correction and ensuing rally that took LL to still higher highs came on slumping upside momentum as stochastics and Wilder's Relative Strength Index (RSI) failed to confirm the higher highs in price.
Such negative confirmation from momentum indicators often serves as an initial warning sign, prompting me to monitor a stock's chart for negative price action.
Moving on to the close-up look at LL's chart below, it is important to note that the stock is currently well above its 200-day simple moving average. To be exact, the stock is trading almost 40% above it, which by historical standards is significantly extended.
After moving sideways for most of the second half of March, the stock was pushed higher Monday by another burst of energy. On Tuesday, LL opened higher and tried to rally again, only to run out of energy, leaving a bearish shooting star candlestick behind on its daily chart.
What's more, the bearish price action on Tuesday came on above-average volume, indicating plenty of price action around a potential medium-term top.
So, with a steep slope, negative divergence by momentum indicators, and bearish price action, a high-probability trade to the short side is setting up. The high of the shooting star candlestick from Tuesday at $71.72 gives traders a clear stop-loss to help keep emotions out of the process.
Recommended Trade Setup:
-- Sell LL short at $69.40 or higher
-- Set stop-loss at $71.72
-- Set initial price target at $63 for a potential 9% gain in 3-6 weeks