Under the Dome
October turned out to be a brutal month for stocks causing a lot of technical damage as you can see when you look under the hood of the indexes at individual stocks. So many have begun to rollover after forming longer term topping patterns, a precursor and setup for potential bigger declines. A good example can be seen in the chart of Charles Schwab, SCHW.
As you can see over the last year, the price of SCHW has transitioned from being in an uptrend (higher highs and higher lows) to now being in a downtrend (lower highs and lower lows). Notice how the $49 area has acted as support during the entire transition. October’s selloff finally pushed the stock below support which opened the door for a quick flush and an almost 19% decline in 10 short trading sessions.
What Was Support is Now Resistance
As with most selloffs, this one too ran out of steam on capitulatory volume and on an oversold RSI momentum as the dip buyers and opportunistic traders stepped in to reverse prices higher. Higher they went to take back the majority of October’s decline. Notice where the recent rally stalled? Right where is should … the $49 area. When support ($49) is broken from the top it becomes resistance ($49) from the bottom.
This is a great opportunity for short sellers to take a position, just under resistance. If SCHW rolls over to retest October’s lows, or even extend beyond there is at least a 15% return opportunity. To manage risk, if you are short there is no reason to hold the position if price moves back above resistance which would subject you to a small 3-4% loss. This works out to be a more than 3:1 reward to risk ratio, right in the sweet spot for risk capital opportunities.