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Educational Article

The Fish That Got Away

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Note: This column was supposed to be published on Monday while I was playing in Las Vegas, but due to some miscommunication it didn't quite make it. Nonetheless, I think it still stands on its own quite well and the points I was trying to make are still valid. Just make sure to view it in the proper context, as it was written Friday night and we've now got 3 days of additional price action under our belts.

Recently in my columns, we've been discussing the importance of getting to know a small group of stocks and following them closely. This should allow us to recognize opportunities based as much on intuitive feel as on the technical behavior of the stock(s). My underlying belief is that a trader can make a consistent income by only trading a small group of stocks. Not only that, but it really doesn't matter what those stocks are. So long as they trade above $20 and there is enough volatility to produce movement, the opportunities will present themselves.

I elaborated on this concept last Wednesday in my Options 101 column, Picking The Right Target where I used the stock ABC as our example. That led to some rather interesting discussions in the Market Monitor on Friday between Linda Piazza and myself. Linda was watching UNH, while I continued to comment on ABC. By the way Linda, thanks for the inspiration for the title of tonight's column!

Alright, those discussions are all water under the bridge, but what I want to focus on here is another stock that I follow quite regularly and I'm kicking myself tonight for missing yet another stellar opportunity. Those that follow the Market Monitor throughout the day have already figured out that I'm going to talk about Autozone (NYSE:AZO). I posted a rather lengthy comment in the Market Monitor on Friday afternoon, which I've pasted in here for those of you that don't have the luxury of following along during the day.

AZO $68.25 (-5.27) Speaking of the fish that got away, I was leaning bearish on this stock earlier in the week, looking for a failed rally near the $82 level (which at the time was the midline of the 2-month descending channel) to give me a favorable bearish entry. I guess I got a bit too stingy there, as the top for the week came in around $80.50. Earnings were out yesterday morning and the stock has been slammed since then, losing more than $12 since the open yesterday. Apparently the higher levels of inventory revealed in the earnings report sparked a sell-the-news event on the once again stellar earnings results.

Currently, I don't see a winning play in the stock due to the sharp drop that has already taken place. There is some strong support down in the $63-65 area, so further downside ought to be limited. However, it doesn't look attractive from the bullish side right now either, due to all the technical damage that has been inflicted. Yesterday's slide took out the 200-dma and today's drop violated the ascending support line ($69) that has been in place since early 2001 when the stock took off on its meteroic rise from a base near $25. That doesn't even take into consideration the ugly picture on the PnF chart, where AZO has far exceeded its bearish vertical count of $73. Hey Jeff, any guidance on picking a new bearish target based on the PnF chart?

My gut feel is that the stock will likely stabilize above the $63 support level and might even turn out to be a decent bullish play next year, but NOT NOW. AZO has now moved into the watch and wait category.

Along the lines of building familiarity that I've been talking about recently, I thought it would be beneficial and instructional to examine the stock in a bit more detail here. Let's start with the daily chart and then see what we can learn.

AZO - Daily Chart

After charging to new all-time highs in late October, AZO entered a shallow descending channel that allowed it to drift down to major support in the $78-80 area. Throughout that decline, I viewed the channel as a possible bull flag -- Big Mistake! I was starting to clue into the error of my ways by early last week, as the stock's inability to reclaim the centerline of that channel indicated inherent weakness. In fact, Tuesday afternoon, I actually entered a resting order to buy a small number of January $80 Puts if the stock reached the $81 level. Oh the pain of being too stingy! Rather than trade up ahead of earnings, the stock stalled out just below my trigger.

Earnings came out Thursday morning, and has been the pattern of late, AZO handily beat earnings estimates by 9 cents. But there were some troubling comments about rising inventory levels and the stock got slammed throughout the day. After breaking down through the bottom of the channel, AZO then proceeded to violate the 200-dma and the carnage continued on Friday with the stock actually breaking below $67 before recovering a bit at the end of the day. A momentum entry as AZO broke below $77.50 (the recent intraday lows) would have worked quite well, but I didn't take it. The primary reason for letting that go was twofold. The earnings results actually looked good, and my objectivity was being clouded by my underlying bullish bias -- that was the big problem.

So here I sit, having missed a great downside play. What do I do now? Do I jump into a bearish play and hope to capture what remaining downside exists? Or do I remove the stock from consideration and find another one to replace it on my watch list? Those of you that have been paying attention know that both of those questions should receive a resounding "NO!" in response.

First off, just because we missed a trade does not mean that AZO won't provide numerous opportunities in the future. There's no sense in throwing the baby out with the bath water. We've invested (or at least I have) a significant amount of energy in becoming familiar with the way AZO trades. It would be foolish to throw away all that hard work. At the same time, it would be foolish to blindly jump into this downside move without looking at a longer-term chart to determine where high-odds action points might exist in the near- and intermediate-term future.

AZO - Weekly Chart

That rebound late on Friday certainly makes more sense now, doesn't it. That rebound allowed the stock to come to rest right on the ascending trendline that began back in early 2001 near the $25 level. My expectation would be for at least a near-term bounce from that trendline, but I don't expect it to last. Why? Look at those weekly Stochastics which are diving back to earth -- very bearish! That said, I think the downside from current levels is very limited, given the strong support in the $63-65 range, which coincides nicely with the 38% retracement ($63.23) of the rally from the late-2000 lows to the October-2002 highs. It's going to take something significant to break below that support level and simply a rise in inventory levels isn't going to do it.

AZO sells automotive parts and to me, (and the company's CEO, according to an interview he did last week on CNBC) that makes it a rather non-economically sensitive business model. As long as people have to drive, they will continue to buy parts for their cars, whether they are new or used. Dipping into the realm of our own Fundamentals Guy (Buzz Lynn), the PE ratio of 16, combined with a steadily-growing revenue stream has me leaning to the long-term bullish camp.

Over the near-term, the bears may do very well shorting a weak bounce to the $75-77 area, as the 200-dma should now present pretty stiff resistance. But I'll be watching for a base to form in the low $60s as an opportunity to initiate a longer-term bullish position. In the meantime, I'm content to watch and wait. After all, that's what a good fisherman does, right?

Postscript: Well now, isn't that interesting? Following the selloff last week, AZO opened on Monday just above that ascending trendline and has proceeded with a tepid recovery above that line so far this week. Investors are thinking that maybe last week's selling was a bit overdone. But take note of the weakening volume. In my mind, this stock is broken over the near term and is going to need time to build a new base. Should we get that lucky, I'll look to short a rally failure in the $75-77 area, as I expect the first test of the 200-dma to be painful for the bulls. But the support found last week in the $66-67 area has clearly defined where buyers will step up in volume to defend the stock. So I wouldn't be buying puts and holding on for the big decline. That's the fish that got away last week. The next big fish (as far as AZO is concerned) just might be a rally back towards the highs next year after that base has been built.

Remember, familiarity breeds profits!


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