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There is absolutely no question that Apple (NASDAQ:AAPL) is one of the most (if not the most) fundamentally sound companies in the entire S&P 500 and it is a stock that everyone should own in a portfolio.

That being said, every so often Apple sees significant selling pressure as investors take profits after a major run-up in the stock. These rather significant sell-offs tend to occur after a huge rally going into earnings, which is also at a time when the market is most likely to see a major correction, i.e. now. (See my earnings preview where I note that Apple will likely sell off immediately after its earnings pop at the open of the following trading session.)

So the big question here is: How can investors capitalize on the incoming sell-off and exactly when is the best time for one to increase their Apple exposure?

The answer to that question largely depends on the key levels of technical support between $280 and $322 a share. Sell-offs tend to be very technically driven with buying interest sitting at different levels of support.

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Taking an Initial Position at $322

The first major level of support sits at $322 a share, which is not only the pinnacle high seen after the release of QE2 but is also the 50-day moving average. Apple has held the 50-day since September and has tended to see rather significant buying interest at this key level in the past. For those interested in risking a potential 10% or so draw down in order to participate in a future run-up to $400 a share, this wouldn't be a bad level to consider an initial position.

Taking a Core Position at $303

However, despite the fact that Apple has tended to hold its 50-day moving average in the past, I believe the stock will soon lose this key level of support due to major selling-pressure in the broader market. While I believe there is a good possibility that the S&P 500 could very well retest its highs for the year sometime this week, the index is on its very last legs for the intermediate term. The market will likely experience a moderate correction in February and Apple will probably be dragged down with the broader market.

Consequently, the next key level of support stands at $295-$300 a share. I wouldn't be surprised to see panic selling momentarily bring the stock below $300 a share like we saw in November. Yet, at these levels there should be tremendous buying interest which could put a bottom in the stock. I'll be looking to take a sizable position at this level - likely around the $303 area. I find this to be the most likely scenario over the coming 4-5 weeks.

Now if we see clear signs that the market has bottomed after a significant market sell-off at that point I'll be taking the rest of my Apple position as the run to $400 will likely be very swift and unwavering. How do we know the market has bottomed after a big sell-off? Usually this is indicated by the ratio of up-volume to down-volume on the NYSE, which suggests funds are accumulating shares in a major way. For example, take a look at the accumulation day on December 1 which preceded the current rally. Two or more accumulation days after consolidation is very telling.

$280 Is THE Key Support Level (>50% Chance We See This Level)

Yet, if on the other hand, we see further selling pressure in the broader market, the biggest level of support for Apple sits between $279 - $282 a share. This is exactly where I'll be taking the majority of my position if we don't see clear fund accumulation. The price of $278 a share was the high set after April earnings and was the previous area of significant resistance for the five-months between April and September.

Moreover, Apple hasn't visited its 200-day moving average for a while now and we tend to see this happen at least once to twice a year. The 200-day moving average currently sits at $280 a share. Thus, this is the most logical place for the stock to go given its massive move from $235 to $350 a share. If the market does end-up seeing a little bit of a larger sell-off, I find this possibility to be more likely than not - I think there is a greater than 50% chance we'll see a sell-off to $278-$282 given the huge market run we've seen since August.

Sell Puts for the More Advanced Investor

Finally, one should always keep dry powder for when extraordinary opportunities present themselves in the marketplace. One thing I'll be considering doing is selling puts if Apple sees the $280 level. The front-month $260 puts would likely carry a significant premium due to overpriced volatility in a steep market sell-off. If Apple falls below $260 a share at options expiration, I would be forced to buy the stock at that level, yet if the stock rallies then I pick up the extra premium which would reduce the cost-basis of the overall position. This isn't always a bad idea in situations where an accumulation day makes it more likely that the coast is clear.

Yet, this presupposes that there isn't some more sinister issue plaguing the overall markets. Obviously, if there are larger market issues at hand, then caution would be the way to go. Still, selling puts isn't a bad way to go for those who wouldn't mind picking up more shares at the lower strike.

So, in summary, it is always best to approach Apple and any stock by taking positions in parts. The first level of major support is at $322 and there's a very fair chance that Apple could bottom at this level. However, as noted above given the run we've seen and the likely incoming selling pressure, the stock will probably sell off down to the $300 level. At this point, a larger position in the stock is warranted,, especially if we see a major accumulation day which might indicate that the selling pressure is coming to an end.

If we see the market pop big and Apple starts to run, then it's a clear sign to get in. Yet, if we see another vicious down-leg, then $282 forms the best entry for a third position in the stock. At this point, if we see consolidation, then more advanced investors might want to consider selling puts to either pick up some premium ahead of an incoming rally or as a way to pick-up more shares at $260 if the stock falls below that level at expiration.

First Position - $322
Second Position - $303
Third Position - $282
Final Position - $260

P/E Ratios Aren't Magical Forcefields

There seems to be this over-reliance on P/E ratios on the part of Apple investors who view them as some sort of a magical forcefield or line in the sand that says Apple won't drop below some arbitrary level "x." While it is true that stocks tend to trade between a P/E ratio range, it doesn't automatically mean that the stock will not fall below the lower-end of the range. P/E ratios are good at judging whether a stock is significantly undervalued and a good investment for the long-term.

Yet, the market can remain irrational longer than anyone can remain solvent. In irrational markets, large investors tend to disregard P/E ratios. This holds true in huge bubbles and in huge sell-offs. For example, it is clear that Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) are severely overvalued and it's a matter of time before both of those stocks see a reversion to the mean. But that doesn't mean that those stocks can remain overvalued for extended periods of time or that they won't reach extraordinary highs which clearly indicate that they've reached bubble territory.

The same holds true in sell-offs. Just because Apple trades between a 17-25 P/E ratio doesn't mean we can't see it trade at a 13-17 range for a period of time. In fact, we've seen Apple fall out of its range in several occasions in its past history. In the end, stocks don't trade on P/E ratios in the near term, they trade based on short-term supply and demand. If a lot of investors take profits, the stock will sell-off and could sell-off to extreme levels. If there is tremendous buying interest then the stock could blow right through the top end of its range and see a 25 or even 30 P/E ratio.

Source: When and How to Buy Apple Shares