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Alcoa Looking Vulnerable

05/04/10 12:23:41 PM
by Donald W. Pendergast, Jr.

With the broad market in a clear distribution pattern, it may prove beneficial to locate stocks already leading the way lower. Here's a look at the stock of one of the US's metal manufacturing giants.

Security:   AA
Position:   Sell

Alcoa (AA) shares rebounded nicely after the March 2010 low, more than tripling in only 10 months, but lately the stock has begun to slide, offering nimble short sellers the opportunity to play for a move down to major support levels. Let's have a look at Alcoa's daily graph, to see what's happening (Figure 1).

FIGURE 1: AA, DAILY. A fresh short channel breakout, one occurring on top on persistently weak money flows, could be a trading signal of value. There appears to be little to stop AA from making a possible trip down toward the $12.30 to $11.90 area, the next support levels.
Graphic provided by: MetaStock.
There aren't too many manufacturing stocks left in the Dow 30 index these days, especially compared to the days when the DJIA was dominated by railroad, steel, automobile, and oil company stocks during the first half of the last century. The US still makes plenty of stuff, however, and when giant stocks like Alcoa, CAT, or 3M take a hit on their earnings due to sluggish sales, it's usually a meaningful barometer of the general health of the economy. Right now, CAT and MMM are doing just fine, but AA seems to be the stock that's sounding the warning bell that all is not well within the ranks of the mighty Dow Jones Industrial Average (DJIA).

The long- and short-term money flows (depicted by the twin Chaikin money flow indicators, set at 34 and 144 periods, respectively) are both in bearish territory, with the 34 looking as if it wants to make a bearish crossover through the 144, which can be a good tool for long-term trend-followers to help confirm the strength (weakness) of a trend. The stock has just made a fresh 21-day channel breakdown (red line on chart) and may have a good shot at making it all the way down to either the support levels at $12.30 and $11.90 (pink shaded area), especially if the rest of the Dow party also decides to cash in some of their chips in the days ahead.

A very simple way to play this potential breakdown in AA:

Put on half a short position at the next session's open, hoping to get a better entry price than today's low at $12.97. Wait for an intraday pullback to a key support level (such as the 21- or 50-period exponential moving average [EMA], floor trader pivots, or major trendlines) and then put on the second half. Place a stop-loss just above the high of the last two sessions ($13.78) and then hold on for a possible ride south to the $12.30 to $11.90 zone, being sure to ratchet the two-bar trailing stop down should the move go in your favor. If $12.30 is reached before a stopout is, take half your position off and bring the stop to at least break even (unless the trailing stop is offering less risk). However, if you believe that AA is on the verge of a major breakdown, maybe even below $11.90, you could also utilize the MetaStock Intellistop (blue line on chart), allowing it to guide you as to where to place and then readjust your trailing stop. For longer-term moves, the Intellistop is hard to beat, as it takes into account the volatility and trend strength, calculating the optimum place to set your stops.

The process of distribution appears to be underway in the major US stock indexes as the big-money interests seek to free themselves of overly heavy equity allocations accumulated over the past 14 months. Will you be the one who ends up buying their unwanted inventory of stock, or will you instead attempt to do what they do and stay on the right side of the market?

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address:

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