This column was originally published on RealMoney on July 31 at 11:04 a.m. EDT. It's being republished as a bonus for readers.

I was shocked to read analysts and traders defending Rackable Systems ( RACK) during its post-earnings death plunge Friday.

A few respected commentators, including RealMoney's Bob Faulkner, even told readers they were adding to current positions.

I strongly disagree with the idea that the torrid session was a buying opportunity in any way, shape or form.

The decision to buy more stock implies that Friday's selloff was the best possible time to take on added risk in this demolished issue.

I believe the stock is headed lower, and will continue to do so for months or years to come.

Of course, there will be bounces along the way, and even a countertrend rally to squeeze overeager short-sellers.

That isn't what I'm talking about here.

Those who pounded the tables last week are long-term players, not short-term opportunists, so they must believe the stock will trade higher in 2007. That's a very poor bet, in my opinion.

Here are 10 reasons why Rackable Systems isn't a buy now, by any stretch of the imagination.

1. The Gap

Friday's gap down triggered a massive 39% decline. This is a spectacular nosedive for any stock, but it is huge for an issue that trades an average of 1.26 million shares a day; we're not talking about a thin little issue that might have been manipulated by a handful of big players.

Consider the psychological damage to shareholders stuck in positions between $32 and $42. These battered investors will keep a major overhang on price development until they're washed out of the system.

With the enormous gap, this process could easily take two years or more. In the meantime, every rally will be seen as an opportunity to dump stock.

2. Volume

The selloff rose to almost 22 million shares traded by Friday's close. That's more than 17 times the average daily volume. This confirms a shock event of extraordinary proportions. Blind optimists might think the extreme numbers represent a selling climax, but they're wrong. The stock dropped out of two-month support, which denotes a breakaway move that predicts far lower prices.

3. Triangle

See the two-month congestion pattern? It's a descending triangle with well-defined support and resistance levels. Friday's selloff completed this bearish pattern and issued a major selling signal. The breakdown predicts a measured decline that matches the spring selloff between $56 and $31. That yields an eventual target between $10 and $15.

4. 200-Day Moving Average

The triangle set up along support from the 200-day moving average. Most stocks will recover when they're able to hold this key price level for a month or two. The sharp breakdown through this line in the sand confirms the intensity of the decline and marks another major selling signal that everyone, including value players, should respect.

5. Accumulation/Distribution

The severe decline in on-balance volume on Friday indicates wholesale selling by institutions with the horsepower to trigger numbers of this magnitude. That leaves a massive population of retail bagholders in the stock. These people can't support price stability in the weeks ahead because they're more emotional than their professional counterparts.

One major OBV sell signal is very hard to see in this extreme chart. The indicator actually broke red line support in the session prior to the earning release. Ironically, this early breakdown signaled technically minded shareholders to sellout positions ahead of the news shock.

6. Red Bar/Green Bar

Let's look at price action in the two-month trading range. Note the size of red and green volume histograms on the buy and sell swings during this period. With few exceptions, volume increased during selloffs and decreased during rallies. This bearish trend peaked in the five days leading into earnings, when three selling spikes dominated price action.

7. Insiders

The volume pattern also suggests that smart money and insiders began exiting the stock in May and continued to do so ahead of earnings. It also suggests that aggressive short sellers took fresh positions on the brief declines within the congestion pattern. Their payday has now come, so perhaps they'll bring some lift to the stock before selling pressure resumes.

8. Daily Range

Why didn't buyers step in to support Rackable Systems on Friday, if it was such a great opportunity? Note how the stock couldn't trade up to its opening price after the first five-minute bar in the session. This denotes extremely weak demand. It also broke the initial trading range to the downside and closed under that level heading into the weekend.

Friday's price action is even worse than it looks, because the broad market moved higher all day, showing forgiveness to a wide range of recently beaten-down issues. Considering that value bulls didn't want to touch this stock on a buyer's day, that suggests that little demand will show up in the weeks ahead.

9. Parabola

This weekly chart is as ugly as it can get. It shows a parabolic rally followed by a parabolic decline. There's a rule for parabolas that I've never seen violated in years of studying chart patterns: A parabola never reinflates once it's broken. It doesn't matter if tulips or tech stocks triggered the original mania; the end result is the same.

10. History

Finally, history warns us to watch out below when a stock drops on heavy volume in a high percentage gap down. The Rackable Systems gap down looks exactly like Apple Computer's ( AAPL) gap down in 2001. What you can't see on the historical chart is that it took that stock almost three years just to trade back to the high of the gap down bar.

That's dead and buried money, like the lead weight in the portfolios of trapped Rackable Systems shareholders.
At the time of publication, Farley held none of the issues mentioned, although holdings can change at any time.

Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from

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