Is Apple's Stock Headed for a Reversal?

Oct.30.09 | About: Apple Inc. (AAPL)

I’ve written extensively about Apple this past year. And, not without reason. Investing in the stock has been a very fun ride ($89 – $200 in a little over 6 months). The Company, whether it be delighting users with new products or frustrating users with its mismanagement of the iPhone app approval process, has managed to stay in the headlines and, as a result, remains a plentiful mine for content. Because Apple (NASDAQ:AAPL) has a contentious group of zealous fanboys, let me start with my Apple Investor Disclaimer and then get on with the post. This is specifically for mac fanboys, so those who have an open mind and understand how one can have a differing views of a Company and the Company’s stock valuation, just skip the blockquote below.

I, the author of The Curious Investor, am currently long Apple stock. In fact, it makes up nearly 10% of my personal portfolio. In my apartment are multiple Apple products including several iPhones, several iterations of the iPod, a MacBook, and an Airport Express. I believe Apple is more than just a trendy consumer products maker and that the iPhone truly represents a new growth engine as the world embraces mobile computing. As an investor, however, I understand that stocks do not only move in one direction. Valuations will overshoot and undershoot true value in the short term and a prudent investor must be aware of this and make decisions with this phenomenon in mind. It is possible for a great company to possess a not very great stock valuation (see: CSCO circa 1999-2000). So, please, leave your hate mail unsent.

Take a look at the chart below (click to enlarge):
Apple 3 Months 10/29/09

Apple’s stock gapped up through the psychologically significant barrier of $200/share following Apple’s earnings announcement last Monday. A headline related pop typically signals a breakaway gap, a stock gap which is typically followed by a continuation but, in this case, Apple’s gap was more suspicious. While related to good news, Apple’s Q4 2009 (FYE 9/26) results were not so much of an upside surprise as previous quarters and investors all but dismissed another characteristically conservative guidance. Moreover, volume doubled prior to the gap up and remained elevated during the stock’s near immediate fall over the last five trading periods, a tell tale signal of an exhaustion gap.

Exhaustion gaps are defined as stock price gaps which follow in the direction of the prevailing trend. A textbook exhaustion gap should be followed by a reversal soon after the gap and then move to fill the original gap. A reversal is confirmed when the gap is filled and price breaches the level prior to the gap.

I realize that I may be early to call this reversal. After all, technical analysis is not clairvoyance. Trends and reversals must be confirmed through chart movements as opposed to “predicted” by the apparent formation of patterns. Traditional technical analysts will always miss the exact top or bottom of a price movement in preference to investing with the certitude of a confirmed trend or reversal. As such, it would seem that the seeming formation of an exhaustion gap here is just a red flag. Apple’s stock has yet to fill the gap, but it has breached the initial gap and looks to be on its way to filling the gap. If so, could it be possible that the Company’s stock is headed for a reversal of its uptrend? Or, possibly entering a consolidation period following an aggressive upward move? If so, it may be time to take some gains off the table and wait for a re-entry point.

Full disclosure: Author is currently long shares of AAPL.