Trader’s Narrative

Last summer I pontificated about the future of Apple Inc. (AAPL) wondering if it was time to sell:

All the smart and “hot” money has been trading it and riding it higher. And you can bet they will run for the exit at the first sign that the party is over. Which is why I watch Apple so closely. I’m seeing a confluence of things which gives me reason to believe that the ride may be over.

So how did I do?

Well, Apple thoroughly spanked me. The only tattered consolation I can cling to is after writing that, the rocket ride known as Apple paused for the rest of the month of June. The only thing that knocked it out of the sky was the general market tumble in mid July. It found footing where it had paused earlier and off it went again when the market recovered.

I’m bringing this up for two reasons. One to review a past call and award myself a meager C- and two, to talk about entry into momentum stocks. Most technical traders agree that momentum stocks provide a great opportunity. As the saying goes, “the trend is your best friend”. Or, bodies in motion tend to stay in motion.

This is especially true when the market has corrected and is about to find its footing again. It is a very rare momentum stock indeed that can completely buck the general market tone. Apple certainly didn’t and it was one of the best performers in 2007.

The general market is like the tide or the waves of the ocean. It is a background element common to all boats (stocks). But some boats have better hulls and more hydrodynamic shapes. So they will react differently to the same common element.

Apple carved out a rounded bottom at $120/share, just as the S&P 500 found its footing. For AAPL that level also coincides with previous important points of support. From there it launched into an astounding recovery which left other stocks in the dust. While it has now easily reached the heights it once claimed in late 2007, the S&P 500 is still more than 8% below its highs of October 2007.

Although most would agree that it is smart to ride the momentum of stock like Apple, but can’t agree when exactly they should enter it. I would suggest that the best time is when the market has exhausted itself within a correction and is about to bounce back. This allows you to define your risk and base it on support levels, removing guesswork.

In last week’s sentiment overview I mentioned some troubling signs were appearing on the horizon. For one, we were once again just below the 1400 level on the S&P 500 index.

But that this important technical junction coincided with wobbly results from indicators like the percentage of stocks above their short term moving average and the CBOE equity only put call ratio made me question the health of this rally.

Although I still think there is ample evidence of a significant long term market bottom, why watch hard won capital melt by riding the wave down when it is this obvious?

Today’s breadth was bad but not horrible. On the NYSE we had 2.5 stocks declining for every advancing. For the Nasdaq the numbers were slightly better but similar.

The big market tell tomorrow will be Apple’s (AAPL) earnings release. Will it power the rally onward or will it put the kibosh on an already faltering one? The stock has run up well in advance of the news but fell today by almost 5%.

Apple has pushed the market’s recovery from the March lows, going from $120 to almost $170. But a healthy market is powered by a wide range of stocks.

In poker, you have to know and watch for “tells”. These are habitual behaviours or reflexive actions of opponents. By watching for them you can know whether they are bluffing (or not). The same type of “tells” exist in the stock market.

As can be seen in the relative strength chart (see below) Apple (AAPL) has been one of the strongest stocks throughout this bull market. It shrugged off the March 2007 correction and kept on barrelling ahead. For me, AAPL is a “tell” for the current market.

All the smart and “hot” money has been trading it and riding it higher. And you can bet they will run for the exit at the first sign that the party is over. Which is why I watch Apple so closely. I’m seeing a confluence of things which gives me reason to believe that the ride may be over.

For one, the sentiment picture is just too bright. Take a look at this recent Economist magazine cover page. Although I’d prefer to see such a glowing cover story on a more general magazine like, say, Business Week, it still is a cover page. The last time I pointed out an Economist coverpage was the one they did for Goldman Sachs (GS). That one did a fine job of alerting GS longs to take profits and go home.

The other reason is the upcoming launch of the iPhone. As the old adage goes on Wall Street, Buy the rumour, sell the news. The closer we come to the June 29th launch of the much hyped iPhone, the higher the expectations. And the easier to fall short of them.

Also a bunch of technical indicators are signalling caution. For one, look at the lofty heights that Apple is trading relative to its long term (200 day) moving average. The last time it was at this level was in January 2006. And you know what happened then.

As well, if you draw trendlines on its chart, you’ll notice that for its latest upleg it has basically gone parabolic. Such a steep rise is simply not sustainable for more than a few weeks to a few months maximum.

Now, some may be looking at the relative strength and thinking that you should always buy strength. But its not that easy. It never is. The last time it peaked, relative strength also looked good. But that didn’t last. And if you notice, during that upleg it was also going parabolic.

Finally, today’s action seems ominous. It was a a wide range engulfing candlestick which took price down 3.5%. I had been meaning to write this post during the weekend but forgot. But even if you missed today’s move, there’s ample room to tighten stops on Apple.

I don’t think it is an automatic short here since it could very well go into a protracted range and work out its overbought condition. But if you’re long, I’d be very careful here.

If you’ve been sharp you have already noticed that MarketWatch has a few new features out. For example, when you’re searching for information on their site they now have an Ajax enabled search which will give you suggestions on the fly. Exactly like my blog search function (top right). Go ahead, give it a try, type something and wait for a second, then scroll down the choices and click.

But that’s just eye-candy. The new feature that I’m really interested in is called MarketPerception. Its a little widget that comes up whenever you’re looking at information for any security on MarketWatch. Here is the widget for Apple:

After you vote, it presents you with the results and a few other pieces of information:

Clicking on more results will take you to a page where you can see what securities are being voted on the most and which have gotten the most extreme sentiment votes, either bullish or bearish. This is probably the most valuable way of looking at this new information.

Not only can you see which security is getting the most vociferous support but you can also see which is attracting the most attention from the lemmings out there. Right now there are very few votes, but this is still a very new feature. I’m also glad to notice that they only allow you vote once. This isn’t a totally scientific poll but every bit of attention to detail helps.

As you know, I really like finding little known ways of measuring sentiment. Here’s hoping this feature will grow up to become a nice contrary indicator.

If I were the owner of any social stock picking site I’d be a tad nervous. It seems that the management at MarketWatch ‘Get it’ and are slowly moving their considerable user base towards a social, interaction based model.