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CME bearish, whicher way you slice it

March 19, 2007

Financials have been a major part of the volatility and selling in the market recently. Banks have plunged so far, so fast they seem way to hot to handle.

Broker/Dealers have a been halted at the 200 MA. But with a series of lower highs and lower lows now in place, It seems that the 200 MA will continue to be pressured and eventually broken, perhaps soon.

The group has steadily shifted down into the red on the big chart.

Chicago Mercantile Exchange has been leading the charge for this group over the past 4 years. With an F/E of 3.50, an amazing 550% growth from IPO to peak in the last 4 years, CME is a mighty stock with fundamentals that back it up. And with all that momentum, a $500 price level and average daily trading volume of around 1 Million, this is a serious trader’s stock. Almost like an index, there is plenty of volatility and potential daily moves here with which money can be made.

Though Chicago Mercantile Exchange is in the process of a buying Chicago Board of Trade, our friend ICE, the Intercontinental Exchange has just put in an unsolicited bid for CBOT. CME sold off hard on the news perhaps because it might prompt a bidding war. Or is this just a catalyst for a stock that has had a huge run and needs to take a breather and pull back a bit?

Though the fundamentals are very strong, we can see that they missed meeting the earnings estimates in Q4 2006. Also, the PEG is 2. The consensus seems to be that 2 should be the ceiling for a stock with a bullish outlook. A stock whose P/E is two times its estimated annual growth can be seen as overvalued. CME is now right on that cusp of overvalued.

Whatever the catalyst, the chart is telling a story. Depending on how you look at it, it tells lots of stories. I’ll look from a few different angles. But most of them point toward the same general conclusion. Down is more likely than up.
The stock broke the trending support line of 4 years and almost perfectly kissed the underside of it and bounced down hard last week.
(Click image for a bigger look.)

A closer look at the weekly shows a support level just above 500. Below that waits a channel whose next support looks to be about 430.

Looking at the daily chart, we can see how the earnings miss was received in late February. Not good. As a result of that catalyst, the long term trendline was broken and tested from the underside forming a potential head and shoulders pattern with a neckline right around 510. I’ll call the height of the pattern, from neckline to head, 90 points. So if the 510 neckline area broke it would forecast a target of 430. It’s kind of scary to make predictions of moves that big. But it puts it into perspective when you consider that from the high of around 590, a correction to 430 is just a bit less than 30%. On a monster growth story stock, I would think that would be very normal, particularly as the broader market is in a correction effort.

Maybe you’re more comfortable with Moving averages than chart patterns. The 200 MA at just above 500 could be a good trigger. Also, just trading below that nice round number, 500, might be a psychological factor in a change of tone here.

Here’s a look with the Investools study set. Three red arrows with the stock having just bounced down off the now descending 30 MA. Perhaps the next bounce down could be the entry from this perspective with a stop just above the MA.

Whichever way you look at it, application of proper position sizing with a stop order just beyond resistance will most likely make for a very good risk/reward scenario. I’ll be watching this one and will try to revisit it with some trade ideas if it triggers a clean entry.

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