Editor's note: Formerly, Chris Schumacher's short trading ideas were available only to subscribers to TheStreet.com's Short Advisor. Now these picks are being offered to RealMoney.com and TheStreet.com readers.
Last spring, shares of Headwaters ( HW) headed swiftly downstream, where they have pooled ever since. The company, formerly known as Covol Technologies, makes products for the energy and construction industries. Its key businesses are alternative energy, producing coal-based synthetic fuels; construction materials, including concrete and cinder blocks; and coal-combustion products such as fly ash, which is used to make building materials. Headwaters' stock price ran into trouble after March 2006. The share price dropped from a 52-week high of about $40 in April to $21 in July. After such a strong drop in price, distribution pressure usually fades as sellers exhaust themselves and price reverts back to former resistance levels. But that isn't the case for the stock price of this company. Price moved in a tight range between $21 and $26, give or take a few cents, from July to the end of the year. When this happens, an area of congestion typically forms because the buyers equal the sellers, which, as the chart below shows, is what developed in Headwaters. During this congestion phase in Headwaters, even though one side may dominate the short-term time frame for a month or two, the continued theme appears to be that distribution pressure has control of the stock price. During late October, Headwaters' share price tried to move up above the $26 resistance but was met with a strong price movement lower, back to $21. After this strong movement lower, the share price has not been able to retest the former resistance at $26. This last failure in October to push the price back to resistance shows that selling pressure is still stronger than buying pressure, with price trying to retest recent highs. At this point, the higher probability move would be to see the price drop back to the support level near $21. Should this occur, a close under $20.85 would validate the downtrend continuation signal, and the trade should offer even more profit potential.
|Headwaters (HW) -- Daily |
The ideal setup for this short trade would be to see an entry at $25 with a stop at $26.50. This offers $1.50 in risk. Note, however, that if the share price moves under $21.75 without first offering an entry, this setup is no longer valid. The first profit target would be placed at $23.50 to satisfy the 1-to-1 reward/risk ratio. Price then has to close under $20.85 to confirm the downtrend. If this happens, the next profit target will be placed at $20 a share. Shares of Headwaters closed at $23.24 Monday.