More Downside Coming In Rollins

About: Rollins, Inc. (ROL)
by: Individual Trader

Multi-month reversal pattern looks like it has played out in full.

We now are getting the reaction rally.

Which gives traders another opportunity to short.

Rollins, Inc. (ROL) is a supplier of pest and termite products to both commercial and residential customers. The firm has a market cap of just over $11 billion. This stock came across our desk from a screen we ran where our objective was to look for potential short candidates. The main stipulation of the screener was the shares at present are trading below their 200-day moving average. The second screener was that the price to earnings ratio was over 30.

In Rollins' case, its present earnings multiple actually comes in closer to 50 which is what we want. Although the lion's share of our portfolio is long our earmarked blue-chip dividend stocks, we like to put short deltas to work to compensate somewhat for our long bias. Today (September 10th) is a good example of why short deltas are important, especially in portfolios where short-term trading is implemented.

With respect to Rollins' valuation, shares are definitely priced above their historical mean at present. Shareholder equity is now almost 15 times lower than the market cap whilst the firm's intangibles continue to contribute a larger percentage to the company's assets. Earnings projections continue to slide both for this year and next. These adverse trends are showing up on the technical chart. As chartists, we believe that any fundamental that could possibly affect the share price has already been reflected on the technical chart. Here is how we see the state of affairs at present.

As we can see from the chart above, we seem to have a triple top reversal pattern in play. In fact, many chartists would say that the bearish pattern has already played itself out because price dropped below last December's low last month. Let's explain.

With any potential triple top reversal pattern, there must exist the presence of a prior bullish trend. Shares of Rollins have consistently been making higher highs since the year 2000.

Volume in Rollins as the pattern was playing out was relatively mild which is typical in reversal patterns. It was only really when price flirted with last December's low did selling volume indeed increase. Once support broke (last December's lows), we could say that the reversal pattern was complete.

Since the 27th of last month, though, shares have been rallying and are now testing the 50-day moving average once more. We believe this rally is merely a reaction rally which means it should not gain any traction above that support level. If it does, then the triple top reversal pattern will be null and void.

The good thing about reaction rallies is that they give traders another chance to enter on the short side. As the chart shows below, the height of the reversal pattern is around $9 a share. At present, Rollins is trading at around $34.25. This means that our price target would be somewhere in the region of $26 a share.

The recent rally in shares has actually produced a buying signal on the daily chart. The 4-day moving average is now trading above both the 9-day moving average as well as the 18. This may catch some technical traders off guard. Why? Because patterns over longer time frames carry more weight in technical analysis. Therefore, the multi-month reversal pattern should overpower the relief rally we are seeing at present. To control risk, traders should first wait for a swing high and then place a stop loss slightly above the highest point of the rally. We will post this to the back office if we move on it.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in ROL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.