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RETRACEMENT


Asbestos Risks Measured

01/22/02 10:55:39 AM
by Eric Utley

Haliburton (NYSE:HAL) sparked fears of asbestos litigation last fall. That fear is spreading to other industrial concerns. Here's the skinny on the developing situation and how to measure and manage risk in asbestos-related stocks, using a simple retracement.

Security:   MMM
Position:   N/A

Fears of asbestos litigation struck several industrial concerns recently. The fears were ignited last fall, when a Mississippi court ordered Haliburton to pay $21.25 million to six plaintiffs. The fears were flamed early last December, when a Texas district court ordered the company to pay $65 million to five plaintiffs, who alleged that Haliburton's Dresser subsidiary -- a spin-off of Harbison Walker, which is now in Chapter 11 reorganization -- manufactured products that lead to asbestos-related disease. It was feared that the Texas ruling paved the way for a new precedent in asbestos litigation.

Dow Chemical (NYSE:DOW) was the most recent industrial concern hit with a ruling. The company reached a settlement in a Texas court two weeks ago. The Texas court ordered Union Carbide, a subsidiary of Dow, to pay 14 plaintiffs an undisclosed amount. And while company officials said that the settlement was, in effect, reasonable, the attempt at dampening fears was ignored by the market. Instead, market participants chose to focus on the ensuing downgrades and the possibility of future rulings against Dow. In the meantime, shares of Dow Chemical shed $9.13, or roughly $8.2 billion in market-cap through Wednesday.

The fear is spreading faster than wildfire. In Wednesday's session, shares of Dow Chemical continued lower along with others, such as 3M (NYSE:MMM) and Honeywell (NYSE:HON). It's difficult to say with any certainty if the fears are well-founded because the outcomes of future rulings are impossible to predict. But traders and investors alike can employ a simple technical analysis tool to gauge the short- and long-term risks associated with each stock in focus.

The tool is a retracement bracket. It slices a meaningful move in price into several pieces, attempting to determine future support and resistance levels. For instance, the chart below depicts the advance in shares of 3M from the September 21 low at $85.86 (A) to the December 26 high at $122 (B). The resulting levels of the bracket are used as future support levels as MMM retraces its advance. Obviously Triple-M is retracing its advance at an increasing rate due to the fears over asbestos exposure. The bracket can aid in risk management through the monitoring of price around the retracement levels.

Figure 1: 3M (NYSE:MMM) - Daily Interval
Graphic provided by: Quote.com.
Graphic provided by: QCharts.
 
In early January, MMM pulled back from its highs to the $115 area (1), which is the site of the 19.1 percent retracement level. The subsequent breakdown below the $115 level had investors on alert for further downside potential and shorts ready to press. MMM opened near the $108 level (2) -- the 38.2 percent retracement level -- and proceeded below it, setting up another shorting opportunity or alerting longs to further downside risks. The stock only stopped dropping after hitting the $100 level (3), which was the 61.8 percent retracement level.

(Of course my observations have the benefit of hindsight. But the precision with which MMM traded around its retracement bracket should add credence to the tool.)

The essence of the retracement bracket is its use in monitoring the progression of risk levels. For instance, MMM's breakdown below $115 (1) in early January shifted risk down to the $108 level -- the 38.2 percent retracement level. The first shift in risk could've been used by a long to stop out or by a short to initiate a bearish bet. The stock's continuation below the $108 level (2) could've been used as another chance for a long to stop out or for a short to press a bearish bet. The breakdown below $108 -- the 38.2 percent retracement level -- shifted risk down to the $100 level (3), which is the site of the 61.8 percent retracement level. Not by coincidence, MMM stopped at its 61.8 percent retracement level through Wednesday's trading. This tool is used by specialists, market makers, and institutional traders in a similar fashion to the above description.

The retracement bracket can be juxtaposed with the current fundamental backdrop surrounding 3M and others encountering asbestos litigation. The progression of price through its various risk levels can be used to determine the validity of the fears and the impact of any future claims against a company tied to asbestos litigation. For instance, a continuation of the sell-off below 61.8 percent retracement level (3) could reveal intensified fears and perhaps a deterioration in MMM's financial position. Such a move will increase conviction as entry points and stop levels are predetermined with the retracement bracket.

The retracement bracket is very adaptable. Both bulls and bears can use the tool to manage risk in these asbestos concerns. For example, a bull, who has done the necessary research and concluded that MMM is not at risk, could use future rebounds from the 61.8 percent level (3) as an entry point. Conversely, a bear, who has found that MMM has exposure to asbestos, can press a short position on a breakdown below $100, whereupon risk would progress down to the 80.9 percent level at $92.79 (4).

At the time of publication, Eric held no positions in any securities mentioned, although holdings can change at any time. Under no circumstances is Eric recommending the sale or purchase of any of the securities mentioned herein.



Eric Utley

Eric Utley is a professional trader and contributing editor to www.OptionInvestor.com, a web-based newsletter that serves stock and options traders. While he cannot give investment advice, Eric welcomes your questions at eutley@optioninvestor.com.

Title: Contributing Editor
Company: OptionInvestor.com
Website: www.OptionInvestor.com
E-mail address: eutley@optioninvestor.com

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