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It seems that I always circle around to a core group of stocks when looking for real changes in the market. However, a wise trader told me long ago to look at the "big boys," because that is where the volume and the money flows are.
And a look at $170 billion home improvement retailer Home Depot (NYSE: HD) tells me things are looking very topppy... again.
For starters, the retail sector in general appears to be in trouble. From luxury retailers to home furnishings to clothing, this was a bad week for earnings. Even positive earnings reports resulted in sell-offs in stocks such as Coach (NYSE: COH). Bad action on good news is particularly bearish because it tells us that overly optimistic expectations must be wrung out of the stock.
Home Depot is due to report earnings on Aug. 16, and expectations seem to be high here, too. But those looking at the chart are likely much less confident.
While HD still trades close to the all-time high set earlier this month, that high barely exceeded the previous peak set in May. And the May high was barely greater than the peak set in November. While it's accurate to say HD made higher highs and higher lows over the past nine months, it's also possible to label the action as something not quite so rosy -- a triangle with a flat top.
Within the triangle, momentum peaks were falling. This tells us that each drive to a slightly higher high was made on less power. On-balance volume, which is a good proxy for money flowing into or out of a stock, also sports falling peaks.
Taken together, we can only conclude that the underpinnings of the stock are weakening, and next week's earnings announcement could easily be the catalyst that sends HD over the edge. Of course, a blow-out report could send shares shooting higher. However, it seems that the market thinks earnings may be good, but not quite as good as expected. If that is the case, the disappointment in a stock that is already starting to lag the broader market should be palatable.
There is one more interesting event that happened this month that serves as the bearish cherry on top. On Aug. 2, Home Depot received a fundamental analyst upgrade, yet the stock scored a key outside-day reversal to the downside. On weekly charts, it helped form a one-week reversal pattern. And in candlestick analysis, it was a bearish engulfing line. Whatever the label, the bottom line was that shares sold off in the face of good news. The last bulls were likely drawn into the market while smart money gladly sold them their shares.
Basically, it was another case of bad action on good news. The market is telling us it knows something (as it usually does).
Because the market's rising trend is still intact and there is time to go before earnings, I'd wait for support around $135.50 to break before selling short. However, as earnings day draws near, some traders may want to change that to a market order with a tight stop in case things go the wrong way.
Recommended Trade Setup:
-- Sell HD short on a close under $135.50
-- Set stop-loss at $140
-- Set initial price target at $120 for a potential 11% gain in six weeks
-- Alternatively, you could more than double your money a move like this using this strategy
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