Chipotle Mexican Grill (CMG) fell almost 15% on Friday after a badly-received earnings report.  McDonald’s (MCD) also tumbled after its earnings release, not helping the industry group and spreading to competitor stocks such as Jack in the Box (JACK) as well.

After having risen about 55% in 2011 Chipotle Mexican Grill (CMG) has reversed course this year and to date sits in the minus column down about 30%.  Such is the life of a stock being played by the trend following crowd.  The good news for traders is that the stock albeit volatile trades well using technical analysis.

From a pure technical point of view the stock started carving out a so called head and shoulders pattern during the second half of the summer and into the fall.  Friday’s sharp sell-off  triggered this pattern to move toward its price target as the stock price broke the neckline of the head and shoulders pattern.

The way we determine price targets of a head and shoulders pattern is by measuring the distance between the neckline and the top of the head and subtracting the result from the neckline.

In the instance of the head and shoulders pattern currently in play on the chart of Chipotle Mexican Grill (CMG) this simple arithmetic calculates a price target of just around $200.  This final price target is another 40 points lower from Friday’s close, or roughly another 16% lower.

What is important to keep in mind when trading head and shoulders patterns, or any ‘standard’ technical patterns for that matter is that like every strategy it boils down to a game of probabilities.  In other words, some patterns work out and reach their optimal price targets and some don’t.  The key lies in trading all qualified signals/patterns and limiting the losses on the losers.

As it relates to the head and shoulders pattern on Chipotle Mexican Grill (CMG), I am using a stop-loss near $285.  Alternatively one could sell far out of the money calls on the stock, using options with expiration at least 3 months out.

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