Johnson and Johnson (JNJ) is at the lower end of a trading range which began late August 2011. As I have articulated in previous articles March 16, 2012 was a very important day with regard to the overall directional trend of the market. The Designated Market Maker in this issue (as well as other DMM's) was extensively distributing his inventory and selling short.
Think of the market as if it were a merchandising operation instead of an auction Market. The primary difference is that in an auction market demand is the driving force behind rising prices. But in the stock market it is rising prices that create demand. This point cannot be overemphasized. There are many competing hypotheses but the single most important truth with regard to the stock market is: Rising Prices Create Demand.
Once a DMM has completed the distribution cycle of his merchandising operations, he has no vested interest in seeing that issue continue to rise. Therefore, he sells short, lowers the price to cover his short positions and engages in the accumulation phase of his merchandising cycle.
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I do not typically include indicators in charts but in this case I have made an exception for the stochastic. The stochastic is most relevant in a range bound market which makes it not only interesting but applicable in this instance.
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The Stochastic Oscillator was developed by George C. Lane in the late 1950s. It is a momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).
Important Note: When I refer to accumulation and distribution I am always referring to the Designated Market Maker's accumulation and distribution. Mr. Lane is focused on the public's accumulation (buying pressure) and the public's distribution (selling pressure). Essentially we are saying the same thing, albeit from a slightly different paradigm. The Stochastic is an overbought and oversold indicator. I agree with Mr. Lane that the public is buying or selling. That fact cannot be disputed. Nevertheless, I suspect it is a common sense fallacy to assume that the public is driving the price up or down based on their buying and selling pressure. That is a bit like the tail wagging the dog (at least to me).
On the basis of the foregoing these are my views and observations:
The Trade:
I suspect the current pullback is not quite over. However I believe a short-term bounce is likely before the decline is resumed. In an abundance of caution you should wait until Johnson & Johnson breaks below $62.75 before establishing a position. In addition, only establish ¼ of your total position at $62.75. Purchase the remaining ¾ of the position at $57.73 with a stop out at $55.37. Do not post your stop out. I have said it before but it is so important that at the risk of being redundant I will say it again. It is too easy for the Designated Market Maker to cash investors out by moving the price below your stop out and move the price right back up again. In addition, when a stop out is triggered it converts into a market order and that could be disastrous if the DMM decides to really take advantage. Remember the "Flash Crash"? I would be looking to exit the trade at an upside target of $65.75.
Depending on whether or not I see distribution during the advance, I would seriously consider establishing a short position. Writing covered calls as Johnson & Johnson approaches $65.00 could also make for a very nice quick premium on the trade. Do not allow this position to exceed 5% of your total portfolio.
Observe the included list of blocks which transacted on May 11. They certainly were sufficient individually to capture my attention but in the aggregate they were all the more compelling. They amounted to over 23,000,000 shares. Notice how the four largest blocks all transacted at the exact same time and all of the blocks transacted at the exact same price. I view these blocks as a single trade. That said there has been very heavy aggregate volume as well.
That's it for now … Have a nice day.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JNJ over the next 72 hours.
