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Option Millionaires was started in February 2008 to provide traders with information about option trading. Led by three career option traders, whose pseudonyms are JimmyBob, UraniumPintoBeans, and Vantillian, they started one of the most popular option trading communities on the web. Now, Option... More
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  • Lessons From Apple & Psychology Of A Downtrend 0 comments
    Apr 28, 2013 6:26 PM | about stocks: AAPL

    The Psychology of the Bearish Earnings Beat

    In the 1980s, Peter Lynch continuously advocated the notion that "earnings drive the market." That appears true, as rising corporate earnings generally results in a rising stock price, and vice versa. So, from a pure binary standpoint, an earnings beat should drive prices higher and an earnings miss should send them lower. Correct?

    Unfortunately, fundamental analysis has two forecasts it must make. First, a fundamental analyst needs to forecast the future of a company (i.e. its earnings). Second, he/she needs to forecast how the market will react to those earnings. That second part is what caught so many Apple bulls off guard last week.

    To understand what happened with Apple's earnings, which beat estimates last week, we need to understand the psychology behind the stock's fluctuations. This method of thought can be applied to essentially any stock.

    It's almost like we have to tell a story about Apple's price history. At $700 dollars a share, Apple was the stock that everybody wanted to own. Few, besides us here (Elliott Wave was saying that $675-$700 was a danger zone) were neutral, let alone negative on the stock.

    So then the stock topped. As you can Volume Profile study, a lot of shares were exchanged within 15% of the top in the past two years. (On a quick side note, if one plots down volume into the April peak of AAPL, you'll see that there was tons of selling into that rally, while the September rally was actually halted by the lack of buyers, which could no longer push the price up.)

    (click to enlarge)

    Since there were a lot of shares exchanged near the top, there were many "weak hands" who were stuck with losses almost immediately. These weak hands are likely the majority of those who still hold the stock today, which is why every rally has been seen as a selling opportunity.

    So let's take Apple's most recent earnings, which was a slight beat. First, the weak hands, already discouraged, are likely swearing to themselves to dump any shares when they can get a small rally. Secondly, those who sold near the top see the stock's downtrend and hear about the company's lowered guidance, so they keep their hands off of it. Then, there are potential investors, who have never bought. A single news event is usually not sufficient to cause long term investors, the ones who really have the impact on price trends, to buy.

    Therefore, what is left? Buyers will not touch the stock, and the mass of sellers who bought at higher prices, while not short sellers (just around 2% of Apple's float is sold short), sell into a vacuum, able to continue to push prices down, regardless of the news. That is the anatomy of a downtrend.

    So what did we learn? Regardless of an earnings beat or miss, the psychology of the market is important. The only thing that will drive the price of a stock up is more demand than supply, and supply remains clearly dominant in Apple. To see when buyers are beginning to rush back into Apple, a simple relative strength line can be used. When the line turns back up, long term investing, earnings beat gambles, and bullish swing trades will have higher profit potential.

    To determine the trend of the RS line, I use a 30 and 50 day simple moving average crossover with the ratio chart. On Thinkorswim, type the symbol (AAPL/$SPX) exactly to retrieve the chart. In the picture below, the red circles represent negative crossovers and the green circles are positive crossovers.

    (click to enlarge)

    So until we see another crossover, Apple's downtrend is still intact. Caution advised!

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