VeriSign's Very Clear Bearish Signs

Editor's Note: Alan Farley's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published April 29, 2002 on RealMoney.

I just got hit with one of those magic moments that makes me appreciate the teaching side of my profession. On Friday I was reviewing how professional advisers were managing a large trust for an elderly relative. The first thing that caught my eye was a big

VeriSign

(VRSN) - Get Report

position. This former highflier

was getting crushed while I was reading the account statement.

A former student then sent me a very unhappy email. This seat-of-the-pants swing trader had his account closed because he couldn't meet a margin call after buying the same stock. So here I was watching two very different market players both taking a bath on VeriSign. And they should have known better. This bubble favorite had been telegraphing its sinister intentions for many months.

This isn't 20-20 hindsight.

In a January column I noted the stock had just broken down from a multiweek pattern and might start a downtrend that could last for "months."

But you didn't have to take my word for it. The price chart flashed repeated warnings in the months since that article. All you had to do was pay attention and exercise a little risk management.

Let's see where highly paid money managers and gunslinging swing traders should have known that buying this stock was playing with fire. It might not save them at this point, but it could help you avoid the next nose dive hiding right around the corner.

First let's go back to the January article. I noted VeriSign had just broken down from a 10-month symmetrical triangle pattern. Big patterns give way to big trends. In this case it gave way to big trouble. The breakdown was a major signal for short-sellers to build new positions and ride the stock down to oblivion.

Breakdowns often pull back to broken support before a new downtrend gathers steam. In fact, this price action confirms the new trend and lets short-sellers pile in at low risk. Notice how VeriSign rallies back into the broken triangle just before collapsing in a 30% decline. That should have gotten your undivided attention, even if you were a long-term investor.

The stock then bounced at $25, where it started to rally back to the original breakdown level once again. Could this represent the end of the ugly decline? Of course, but only if the stock breaks through a few major resistance levels.

Unfortunately, VeriSign does the exact opposite. It reaches up and tags the old low, but then reverses in a gap down. To make matters worse, this price level also represents strong resistance from the 50-day moving average. Those still holding the stock should have taken an immediate exit as soon as this reversal took place.

It gets worse from here, not better. The failed rally becomes the head in a well-defined head-and-shoulders pattern. Note how long it took for this bearish formation to develop. The most negligent trader or investor had plenty of time to plan a way out of the gathering storm, or at least find a way to take advantage of it. The pattern finally breaks down on April 23. But even then, there was still time to get out with your trading capital (and self-respect) intact.

Notice the three trading sessions after the head-and-shoulders breakdown. The most bullish scenario would print a bounceback to the broken neckline, where the downtrend would likely resume.

But there's never a guarantee the market will be so kind, or give you a second chance. So during those three days, the stock had no upside and unlimited downside. Professional money managers and swing traders alike should have taken notice, and controlled their risk immediately.

Readers may wonder about that bullish hammer the day before the big gap down. In fact, that's where the swing trader thought he could catch a falling knife.

But look at the short length of that bar and the mediocre volume for that session. Neither of these elements screams "climax," especially with the downside threat. The reward of buying into that candle never justified the risk.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called

HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley had no positions in stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to

Alan.Farley@TheStreet.com.

Also,

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