Yesterday's trade at $60 even had me thinking shares of Merck (NYSE:MRK) was an attractive bearish play for traders as this created a spread-triple bottom sell signal on the point and figure chart. With heavy volume, it sure looked as if the stock was under further distribution. Since our prior retracement bracket gave little insight to a level where a bear might look to lock in some gains, I'm going to roll down retracement to give us some levels where we can better asses future risk reward for those short the stock.
Merck Chart -
All I'm doing is leaving my prior anchor at the $80.85 level. Since 0% had been at the $60 level, I want to keep the integrity of that level. By grabbing the bottom part of retracement and pulling it lower, I then "fit" the 50% retracement level at $60. The result is 38.2% at $55, 19.1% at $47.13 and 0% at $39.18. According to Professor Earl Davis' study, the spread-triple bottom is profitable in a bearish trade 86.5% of the time, with an average gain for a bear of 24.9%, in the time span of 4.6 months on average. Given the spread triple bottom occurred at $60, then a 24.9% decline from there may have the trader looking at put options that expire 5-6 months from now and targeting the $45 level. We also see the 19.1% retracement level at $47. Now all a trader has to do is monitor the scenario from the point/figure chart data, along with some levels from our retracement bracket. Stops can be placed just above our new 50% retracement bracket level of $60. Should the stock drop below the $55 level, then a trader could simply lower their stop just above there, or consult the point/figure chart to see where a "buy signal" might occur and place there stop at that level. Very systematic and disciplined way to trade.
A longer-term investor that is still bullish the stock, may also have some insight near-term. Nothing wrong with a long-term bull writing some covered calls as he/she assesses potential trading over the next several months.
In fact, I know of one investor that has held shares of Merck (MRK) for years with an average cost basis near $20. She's done quite well with her long-term holding and just loves the stock "as it's a good company." Even "good companies" have road bumps from time to time and sometimes those bump can turn into some deep potholes. This its smart to try and take some type of action to hedge or further reduce cost basis.