In simplified terms Sir Isaac Newton’s law of universal gravitation states that ‘what goes up must come down.’ He of course was referencing physical objects, yet I often observe similar phenomena in the stock market. These moves in the stock market however are more of the mean-reversion kind, where investors get too giddy and push up a stock too much too quickly so that in the intermediate term buyers are exhausted and as a result the stock must drop back to a zone where a healthier balance of buyers and sellers exist.
For a recent example we don’t have to look very far, as trading action in Apple Inc (AAPL) has displayed exactly such a mean-reversion move. The stock had been in a nice and defined trading up-trending range from 2009 through 2011, but in early 2012 the stock went vertical and broke out of the channel to the upside. In the second half of 2012 however the stock finally ran out of steam and has been in such a mean-reversion move to the downside ever since.
Any stock that rises too steeply too quickly is prone to these mean-reversion moves. There are some exceptions of course, such as takeovers or major FDA drug approvals.
A stock that has recently exhibited such a vertical move appeared on my radar late last week. Fibria Celulose SA (FBR) had a nice yet steep up-trend from June through November, and in the first week of December shoot straight up and out of the trading channel.
The 35% rally from late October to last week also led to severely overbought levels on the daily charts, as displayed by the Stochastic and RSI indicators.
Furthermore, since the recent move that seemed to have defied gravity, three concerning daily candles appeared on the charts; first an inside day on December 6th on massive volume, followed by two doji candles. A series of such candles in overbought conditions following a vertical move in the stock sets up a good risk-reward short-side opportunity.
With a defined stop at the highs from December 5th near $11.60 and a target around $10.50, this is a clearly laid-out mean-reversion setup.
Beyond this mean-reversion move to the downside, the stock remains in an up-trend that could get the stock up to $13.50 in time. Hence, once the stock has consolidated somewhat to the downside, profits should be taken.
