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Potential "Bearish Signal Reversal" in ERTS

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One of our subscribers was so kind to send me an e-mail today regarding a "bearish" play list on OptionInvestor.com. The subscriber has been studying his point and figure charts and was wondering if I thought Electronic Arts (NASDAQ:ERTS) was a good "bearish play."

While shares of ERTS are trading lower today, I'd be careful if trading short/put the stock. In this year "free gift" to annual subscribers, we talk about "probabilities of point and figure charts" and I see what could be a "bearish signal reversed" pattern forming in shares of ERTS should the stock trade $65.

Electronic Arts - $1 box

A quick look at the p/f chart of ERTS shows the stock successfully tested its upward support trend (bullish support) at the $50 level back in November (red b). From there, the stock gave a quadruple-top buy signal at $58, then launched higher to $66. Now the stock has started to set some lower highs and lower lows. The "bearish signal reversed" is a chart pattern identified by Professor Earl Davis. The characteristics are this.... "A series of lower tops and lower bottoms. A quick reversal up and stock breaks out ($65). No accumulation occurs and 7 columns are needed."

I would point out that shares of ERTS are currently in a 6th column and a reversal up into X at $62 would have the column reversing up into a 7th column. Professor Davis' study notes that the bearish signal reversed is profitable for a bull 92% of the time, with an average gain of 23.2% in 2.5 months.

What makes the bearish signal reversed? After a "blow-off" move like we've seen in ERTS from $58-$66 we may see some bears shorting the scale down. What creates a potential powerful move higher is the "quick reversal" high, that traps some bears short and the move higher creates a surge in demand from committed bulls and covering bears.

While the "bearish signal reversed" has NOT occurred in the chart of ERTS, there is the possibility it could. I would be careful with a bearish trade in the stock, especially with the stock sitting above some many levels of potential support. The current vertical count is bearish to $54

This is one of those trades that to me looks "so, so", and I'd follow with a rather tight stop, just above $60.50 for bears.

For the straddle trader, a decent trade might be in the Jan $60 calls (EZQAL) $2.95 and Jan $60 puts (EZQML) $3.60.

I would also note that this stock currently trade above its 200-day and 50-day MA's of $55.65 and $57 respectively. From the bar chart and point figure chart we see quite a bit of potential technical support near $57.

Electronics Arts - Daily Chart

Don't get me wrong! I'm not trying to "fade" the play picker that likes ERTS short/put. He's winning today as the stock trades lower, but I'm just looking for trouble and a potential exit point should the trade work against me. The past two sessions, the stock hasn't traded much above the $60.53 level and with bullish support and moving averages down near the $56-$57 level, I would be willing to risk much above $61.00.

Relative strength check

Another thing I like to do is put a stock to the test of relative strength and see how it is trading against a broader market average. The relative strength chart of Electronic Arts vs. the S&P 500 shows "rs is on a buy signal, but in a column of O's." For the most part, this signifies a stock that has been stronger than the broader market, but currently pulling back.

Relative Strength Chart of ERTS vs. SPX

As you can see, the RS chart is mixed. Longer-term bullish, but near-term bearish. With so many things right now looking lower, I do think a trader can be playing bearish, but I wouldn't be willing to risk a lot in the trade. Both the longer-term trend from the point/figure chart and RS are bullish. With the stock trading above the 200-day MA, that too is a longer-term bullish sign. With all that said, the trader now gets the feel he/she should be looking "bearish" only on a short-term basis. There's a lot that has to happen to the "downside" for some good gains to occur. Perhaps this is why I'd rank this one as "so, so" right now. About 50% bullish and 50% bearish. I like to find trades that tip the scale in a more "certain" direction.

Jeff Bailey
Senior Market Technician
Option Investor

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