Trader’s Narrative

Now that the Bear Stearns (BSC) saga has ended with their absorption into JP Morgan (JPM) for $2, I wanted to go back to the previous time that I looked at the stock, back when it was trading at ~$140 (!).

I sounded a warning note because, in contrast to the previous multiple times until then, BSC had broken down relative to its long term moving average (see graph in link). And even if it was able to claw its way back, the damage had been done. There was a tremendous amount of resistance overhead. Of course, hindsight is 20/20 and we now know it never traded at those levels again - and never will.

I know you want to avert your eye, but can’t. So here’s an analysis of how the whole thing went down (literally):

Not only has Bear Stearns already decoupled from its long term moving average but basic technical analysis is showing that this stock is heading down. The down trend is not only supported by the medium (50 day) moving average in blue and the long term (200 day) moving average in red, but also by the way that both successive tops and bottoms are lower than the previous ones. At each attempt to rally, price is smacked down, unable to mount any real threat to the general down trend.

The most serious attempt to put a floor under BSC was during August 2007 when everything under the sun made an intermediate bottom. But in Bear’s case it quickly melted away. If you were watching BSC in February, you had to wonder if more of the same was in store for this beleaguered financial stock.

In March, prices are once again scraping the $70 level. Will it hold and carve out a triple bottom? or break down? You have to remember the general principle that every time a price level is hit, it becomes just that much more fragile. Think of it using the analogy of a glass floor. It may hold one or two times, but if you keep jumping up and down on it… eventually it will crack and you’ll fall through. Which… is exactly what happened:

At this point, if you were still holding long (in keeping with the triple bottom thesis) you had your chance to get out with a small loss. The market had clearly put in a lower bottom and outside of technical analysis, the news and rumors about Bear Stearns’ health couldn’t have been more negative. That is if you were listening to anyone except Bear Stearns executives (never listen to corporate spin from any company).

And if you didn’t listen and bought or held on to your shares… well, the market tried to talk to you. But you simply weren’t listening.

Come to think of it, the Bear Stearns’ implosion is very similar to the E*Trade (ETFC)example that I went over a few months ago.

The only difference is that rather than languish at low single digits, it will be swapped for 0.05473 shares of JP Morgan common stock.

Tsk, Tsk
Oh and this video is making the rounds on various blogs and forums:

At first glance, it seems Cramer was incredibly wrong. After all, the video shows BSC trading at $62.97 (March 11th, 2008). This was just 2 days before the stock fell to $30… and three trading days before it opened at single digits.

But what people miss is that the question wasn’t about Bear Stearns stock but about its solvency.

So yes, Cramer was correct: the funds and securities deposited with BSC were not in danger.

But if you actually bought the stock, like this poor guy (on margin!!), then that’s a whole different story.

I didn’t lose any money in the implosion of E*Trade, but I still wanted to take a look at what happened from a technical analysis perspective to see if I could pick out any warning signs.

Here is the chart of E*Trade Financial (ETFC) prior to any nasty stuff:

Meandering with a mazy motion and rangebound - as the moving averages show by flat lining.

Moving Averages Legend
The green line is the simple 50 daily moving average, the blue the 150 daily moving average, the red line the 250 moving average.

The next important event was on July 24th, 2007 when price approached, yet again, the floor of the trading range:

Ranges occur because people come to believe that above a certain price, a stock is too “expensive” and below one, too “cheap”. The longer a trading range remains, the more investors and traders become active participants. And the more participants, the more stop-losses which accumulate near the same obvious price points.

Lesson #1
When a range is pierced to either direction, the stop losses of one side are triggered and as the “wrong” side investors and traders scramble to limit the hemorrhage to their accounts, they in effect fuel the move… creating a strong trend.

Which is exactly what happened:

Lesson #2
The rest of the market wasn’t doing that well either at this time, so E*Trade wasn’t the only stock suffering - especially in the financial sector. But the important point is that E*Trade had no relative strength compared to the market:

Lesson #3
The warning signs were there: the “death cross” on the moving averages, the lower lows and the lower highs being carved on the chart as market swatted the shares around.

So it wasn’t surprising when the insult was added to injury and a massive gap down took the shares to the low single digits and talk of bankruptcy started to float about E*Trade like vultures:

According to technical analysis, the price itself was telling you to stay away from this (at least, from the long side!). The best thing you can do if you did lose money on E*Trade (ETFC) is to learn from the experience and apply it to the next trade.