Beacon Roofing's Still Leaky

The action in Beacon Roofing Supply(BECN Quote) has not followed some key trading principles, which initially signaled the bearish bias in this stock. Moreover, it still looks like a potentially profitable short sale.

The shares enjoyed a rising price from late 2004 through 2005, topping out in 2006. But the most important aspect to this uptrend is that the shares did not experience any Stage 1, 2 and 3 price movement. Let me explain.

I talk a little bit about these stages in my book, Techniques of Tape Reading, and I went into great detail this past week at a conference in Rimini, Italy, where I presented tape-reading principles to a group of 400 Italian traders. As I was reviewing charts for this presentation, Beacon Roofing showed up on my radar as a possible short-term swing setup for a short trade.

Stage 1 starts with the "Trend Beginning" principle. At this beginning stage, institutions are able to accumulate large positions in a stock without drawing attention to the stock, which could make it harder to build the position around the core cost basis they desire.

In fact, institutions did such a good job of building their positions in Beacon Roofing that the share price moved from $10 to $22 without seeing very much volume increase at all.

After the "Trend Beginning" stage comes "Trend Confirmation." This is Stage 2 of price appreciation and is normally related to an increase in average daily volume and price action that moves in a 45-degree angle higher.

Eventually, the rise in price and volume attracts the retail crowd to the stock, causing volume to increase dramatically. This is Stage 3. Price movement becomes almost vertical until an exhaustion point leads to the creation of a resistance level. This is what I have referred to many times before as "euphoria."

The interesting part about Beacon Roofing's move higher is that even though its share price climbed vertically to a resistance area in 2006, volume didn't show any dramatic exhaustion. Without volume exhaustion, the price should have continued higher.

Using the trading principle that what should go higher in fact does go higher, this stock has shown bearish tendencies ever since that topping action. More to the point, each new rally has been met with much larger sell-side volume. The downtrend channel that has formed since the 2006 resistance level developed, combined with larger volume distribution, shows that a higher probability exists for more downside.

Beacon Roofing Supply (BECN) -- Weekly

The ideal setup for this roofing company would be to see an entry at $18.50 with a stop at $20.10. This offers $1.60 in risk. The first profit target would be placed at $16.90, where partial profits could be taken. The final profit target would be placed at $12.75.

If the price closes under $15 without first offering an entry, this setup is no longer valid. Shares closed at $16.89 Monday.

Update on Previous Pick

Trex(TWP Quote) closed under $19.65 without first offering an entry. This trade setup is no longer valid.