AudioCodes ( AUDC - Get Report) has shown up on the bears' radar after reporting first-quarter earnings that were below Wall Street expectations.

Distribution pressure in shares of this communications-equipment maker built up during the latter half of 2006, and the levee finally broke in March when the stock price dropped from just above $9 to just under $7. Last week's earnings disappointment only served to increase this distribution pressure.

Normally, when you see a selloff this strong in a stock, it attracts a flurry of bottom-fishers, along with those who were previously short the stock and are now covering. In other words, the easy money on the short side has already been made.

The result of capitulation typically is a strong reversal, with the share price usually moving back up to where the initial selling occurred. However, this has not been the case for AudioCodes.

Instead of experiencing a strong reversal, distribution pressure kept its stock price locked in a two-month congestion range. Congestion after a strong movement lower indicates two things: First, the lack of continued buy-side pressure from bottom-fishers shows that they do not believe in AudioCode's long-term fundamentals and are looking to exit for quick profits. This lack of support leaves price vulnerable to distribution pressure.

Second, traders who would normally be covering their short positions have instead elected to push for additional profits, expecting more downside ahead. Most likely, they have already taken some profits but are willing to continue holding a portion of the position given their expectation that price can move even lower from current levels.

The fact that two capitulation phases in this stock have failed to create a strong reversal means that a higher probability exists for more downside. I would reiterate, however, that the easy money in this stock has already been made, when the price fell $2 in March.

AudioCodes (AUDC) -- Daily

The ideal setup for this trade would be first to see the price move back to the congestion range, with an entry at $7. The stop would be placed at $7.25, which is just above the last congestion high. The first profit target would be $6.25, and final profits could be taken at $5.50.

I don't expect AudioCode's stock price to move too far below $5 in the near term, given the basic short-selling rule that says stocks are not marginable under $5. This should create some artificial support for the following quarter.

If price moves under $5.85 without first offering an entry, this trade setup is no longer valid. The stock closed at $5.97 Monday.

Updates on Previous Picks

  • Christopher & Banks (CBK) closed under $16.90 without first offering an entry last week, invalidating the setup. This stock is no longer on the Watch List.
  • PetMed Express (PETS - Get Report) is still open with the entry at $12.80. The stop was lowered to break-even at $12.80 last week and remains unchanged. Partial profits were taken at $11.35, and the final target is at $9.50. Shares closed at $11.08 Monday.
  • Rohm and Haas ( ROH) traded below $50 before offering an entry, which invalidated the setup. This stock has been taken off the Watch List.

At the time of publication, Schumacher had no positions in stocks mentioned, although holdings can change at any time.

Chris Schumacher is a financial trader, speaker, writer and co-author of Techniques of Tape Reading. While Schumacher cannot offer specific investment or trading advice, he appreciates your feedback; click here to send him an email.