For Trex, It's Watch Out Below

Shares of Trex(TWP Quote), a company that makes decking and railing products from a composite material, ran into trouble almost two years ago, and the end is not yet in sight.

The stock has been weak since topping out in late 2004 and early 2005 above $50 a share. In mid-2005, a capitulation phase dropped the share price from $38 to $24.

This type of capitulation normally results in a sharp reversal, and the stock eventually climbs back up to the price level where the decline started. In this case, following the drop to $24, Trex could barely break $30 a share before failing again.

After seeing new lows in late 2005, the price tried to break above $30 twice in 2006. But on both of these attempts, distribution pressure increased above $30 a share. This ultimately knocked the stock price back to the former support that was formed at $20 in late 2005.

Since the November 2006 test of $20, Trex's share price has tried only once to regain $30. This move was quickly met by distribution pressure at lower highs, and the stock price is now retesting the $20 support again.

This series of lower highs in combination with the $20 support level is forming a bearish technical pattern known as a descending triangle. In this pattern, a support level forms, pushes price to a lower high, and then the stock tests the support level again.

Each time the stock tries to move up, the range becomes narrower, as distribution pressure gets stronger at lower highs.

Eventually, the narrowing of the range leads to an explosion to the downside that allows short exposure to reap the benefits of lower prices. In this case, Trex is poised to see a break of the $20 support, which would create a downtrend continuation signal.

Trex (TWP) -- Weekly

The ideal setup would be an entry at $21.50, with a stop at $23. This would offer $1.50 in risk. The first profit target would be placed at $20 to serve the 1-to-1 reward/risk ratio. The final profit target would be $18.10, which is just above the Feb. 1, 2002, support level of $17.95.

If price closes under $19.65 without first offering an entry, this setup is no longer valid. Shares closed at $19.72 Monday.

Updates on Previous Picks

• AudioCodes(AUDC Quote) moved under $5.85 last week, which invalidated the setup. The stock is no longer on the Watch List.
• PetMed Express(PETS Quote) hit its stop at $12.80 on Monday and the position was closed out.