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Over the past week, global markets reacted sharply to the terrible news that a British lawmaker was murdered for her view that the U.K. should remain in the European Union. It's believed this will push undecided voters to choose to remain.
As fears of a Brexit wreaking havoc on the markets subsided, oversold stocks, European currencies and even domestic interest rates rallied quickly. But this week, when it seemed even more traders jumped on board with the rally, basic materials stocks appeared to fail. While steel, paper and chemicals stocks did gain, they closed near their lows of the day Monday. And those that held on better fell on Tuesday as the broader market gained.
This tells us something is amiss in the group -- no matter what happens with the Brexit vote. After all, basic materials are on the bottom of the economic food chain, as they supply the inputs to many other industries.
One stock that fared particularly poorly was chemicals maker Olin Corp. (NYSE: OLN). The company manufactures products such as caustic soda, bleach, vinyl and sporting ammunition.
On the chart, we can see Monday's bearish outside-day reversal on a day when the broader market was up nicely -- a bad sign.
The trend from the February bottom is still intact, so this bearish trade is in the "setting up" phase. But I'm seeing fairly strong divergences between price action and several momentum indicators.
Price made a higher high in June, but the Relative Strength Index (RSI), for example, made a lower high. Typically, price action changes directions to follow the indicator. Put another way, the brakes are on but the car is still moving forward. Eventually, it will stop.
To put the 2016 action in context, OLN has retraced about half of its 2015 slide. But shares have nearly doubled since their February lows, and that sort of bullish run is hard to sustain.
Should OLN follow through to the downside after the reversal, the target would be around $20, which represents the May low and would also be a 38.2% Fibonacci retracement of this year's rally.
The parabolic stop-and reverse indicator, which trails stops at increasingly tighter levels, has already fired. Rather than use that as the trade trigger, though, I prefer to have it in place as an environmental indicator telling us that the trend has weakened considerably in advance of rolling over to the downside.
I want to wait for the trendline (as drawn on a log scaled chart due to the extreme percentage price swings) at $23.75 to break before selling. We won't give up much profit potential by doing so, and it will reduce our risk, especially given the high levels of volatility and the market on edge ahead of the Brexit vote.
Recommended Trade Setup:
-- Sell OLN short below $23.75
-- Set stop-loss at $24.95
-- Set initial price target at $20 for a potential 16% gain in four weeks
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