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Braking on AZO

We are going to establish a net bearish position for AutoZone because the stock formed a double top, and that coupled with slowing upside momentum, probably means a near-term correction.

When this stock market rally began way back at SPX 1040, I wrote about the strong likelihood that many would use a rally to talk about why technical analysis is useless. Recall, at the time there was plenty of bearish technical talk. There was a Hindenburg Omen, a "death cross" and overwhelming bearish sentiment.

Of course, with the rally through SPX 1130, all of that has changed. Bears have been replaced with bulls -- and perhaps correctly so. The SPX 1130 level was extremely important as each and every rally to that level had previously been aggressively sold. In theory, the move above that point means those sellers "lost" and have now been replaced by buyers.

This is important because, make no mistake about it, SPX 1130 is now critical support and absolutely, unequivocally must hold on a closing basis. The reason I am taking a more cautious tone with this post is, bears do have a way out of their current uncomfortable situation. A close back below SPX 1130 turns recent bullish converts back into bears.

I know, it all seems like too much technical mumbo jumbo. I know it seems improbable -- and perhaps it is -- but it could happen. And that is why, despite all of the current enthusiasm for stocks and talk about the uselessness of technical analysis, we need to be careful. A close below SPX 1130 would be extremely bearish.

What are the odds such a close takes place? The first test of a key technical point is usually successful. This means bulls are very likely to be aggressive buyers back at 1130. This is the "Johnny-come-lately" trade whereby traders who missed getting long on the initial breakout, use weakness to add new positions. Given all of the talk about the Bernanke put, this trade makes a great deal of sense. Just the same, be cognizant of the fact what a close below 1130 means.

Today, I am going to establish a net bearish position for AutoZone (AZO) - Get AutoZone, Inc. Report. This has been a great stock for bulls, but recently the stock has failed to move decisively through the $222.00 area on two separate occasions. AZO formed a double top, and that coupled with slowing upside momentum, probably means a near-term correction. I will sell the November 220/230 call spread if I can do so for a $3.50 credit.

Trades: Sell to open AZO November 220 calls at $5.70 or greater and buy to open AZO November 230 calls for $2.20 or less.

At the time of publication, Terry Bedford held no positions in the stocks or issues mentioned.

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Terry is the Founder and President of Bedford & Associates Research Group. Terry writes for AOL Finance and MSN Money and is regularly quoted by the financial media.

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