Breakdown Points to a Fast Sell-off in This Exchange Operator

Over the past two weeks, the heated debate surrounding high-frequency trading (HFT) has once again made front-page news. Renowned author Michael Lewis came out with a new book called "Flash Boys: A Wall Street Revolt," in which he is decidedly critical of HFT. The book, along with the FBI disclosing a year-long investigation into HFT practices, resulted in dozens of fiery articles and television interviews.

High-frequency trading was first brought to the attention of the masses by the 2010 "flash crash," when the Dow Jones Industrial Average dropped more than 1,000 points, or about 9%, in five minutes, only to recover a few minutes later.

The "flash crash" is widely blamed on HFT, but one could argue that it prevented the crash from getting worse and provided the liquidity for a quick recovery. While the issues surrounding high-frequency trading do need to be addressed, I personally believe the negative side effects of HFT for individual investors trading equities with time frames longer than one day are minimal. 

Partially as a result of the recent flare up in discussions about HFT, the stocks of exchange operators have taken a serious hit. The rationale for this is that should high-frequency trading get curbed, then the exchange operators would see much less volume (i.e., business). 

Over the past month or so, shares of IntercontinentalExchange Group (NYSE: ICE), CME Group (NASDAQ: CME), CBOE Holdings (NASDAQ: CBOE) and Nasdaq OMX Group (NASDAQ: NDAQ) are off roughly 10%-15%, and as a result, have snapped some crucial technical support levels. 

Today, I see a short-side opportunity setting up in CME Group, which operates the CME, CBOT, NYMEX and COMEX exchanges. 

Looking at the multiyear chart, we see that by December 2013, CME finally managed to retrace 50% of the nasty sell-off from late 2007 to early 2009. 

CME Stock Chart - Weekly

It's funny how the tone of a long-term chart can change over the course of 12 months. In the case of CME, in January 2013, it had just begun to break past a multiyear diagonal resistance line, which was decisively bullish for the intermediate term, and ultimately led to a breakout of its multiyear sideways pattern. 

But resistance around the $85 level proved to be too great, and the tone of the chart again shifted. As the sell-off of the past month continued into this week, CME broke back into its multiyear channel, and thus, has erased the positive posture that was present for much of 2013.

On the daily chart below, it became increasingly clear that the stock was tracing out a classic head-and-shoulders pattern.

CME Stock Chart - Daily

The 50-day, 100-day and 200-day simple moving averages remain clustered, and CME found important resistance there in late March. This resistance area also formed the right shoulder of the head-and-shoulders pattern and pushed the stock to break below its neckline around $70.50.

With CME back in its multiyear trading channel, the stock looks to have an additional 5%-10% downside. But I would wait for a near-term bounce to retest the neckline around $70.50 to enter a short position.

Recommended Trade Setup: 

-- Sell CME short at $70 or higher
-- Set stop-loss at $73
-- Set initial price target at $64 for a potential 9% gain in 1-3 weeks

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