Two Ways to Play Ailing Charming Shoppes

Specialty apparel retailer Charming Shoppes(CHRS Quote) has been in a downtrend since the fourth quarter of 2006. The stock price has moved from just over $15 to the range congestion near $11 this summer.

Almost all of the gains the company saw in the third quarter of 2006 have been erased. At the end of June, Charming Shoppes announced that its second-quarter earnings would fall short of earlier projections -- which led to a sharp drop in the share price.

When this happens, normally most of the negativity is immediately priced into the stock and the price reverses as the selling exhausts itself. However, instead of this reversal scenario, shares of Charming Shoppes remain congested near the $11 level. This suggests that distribution pressure could still be strong, and the stock is seeking the most stable former support from August 2006 at $9.70. A break of the current range support at $10.55 would confirm a downtrend continuation signal.

The risks associated with this type of setup revolve around the reward/risk ratio. Charming Shoppes has already come down from just over $15, and the next major support is at $9.70. Even an entry at $11 would only yield $1.30 in profits. So the easy money on the short side has already been made. This last bit of potential is the hard money, and it takes a fair amount of patience to wait for an entry point.

There are two ways to trade such a setup. The first is to wait for a small break of resistance, and in the case of Charming Shoppes, short into the break near $12. In this case, using $13 as a stop level would yield about $1 in risk. With the entry closer to $12, the reward increases -- but the probability for the trade to yield that profit is lower.

The other way is to trade the break of $10.55, looking for an entry closer to $11, with a stop just above the range resistance at $11.40. This offers about 40 cents in risk, with a $1.30 reward.

Charming Shoppes (CHRS) -- Daily

However, this entry strategy is prone to a rinse. A rinse occurs when the price breaks just enough to suck in the short exposure, then spikes the stock above the invalidation point just to take out that liquidity. This has been happening quite often in the recent broader-market uptrend.

Therefore, I would prefer to use the first strategy to find an ideal setup for this trade. Look for an entry near $12, with a stop at $13. Once the stock breaks below $10.55, you can then look for a price target of $9.70 to $10 as the profit range. If the price moves under $10.55 without first offering an entry, this trade is no longer valid. Shares closed at $10.73 Monday.