This Stock's Looming Sell-off Could Produce Fast Returns

Serge Berger
March 14, 2013

Industrial giant Honeywell International (HON) has staged an impressive rally off its October 2011 lows. While the stock's incline had taken a stair-step approach until recently, in January, HON broke to the upside of a multi-year resistance zone, and in recent days, the slope on its chart has gone from steep to vertical. In fact, the entire rally off the 2011 lows has created an ever steepening slope that now looks ripe to lean against for a short trade.

As of Tuesday, the Dow Jones Industrial Average has rallied eight straight days, and looks set to make that nine today -- something that has not been done in more than 16 years. In the grander scheme of things, such statistics don't matter much to me but rather make for easy-to-understand financial television factoids that may or may not sell advertisements. 

In the current case, however, the vertical slope of industrial stocks in the U.S. market is now setting up for one of my classic "gravity pull" trades.

Simply put, a gravity pull trade setup forms when a stock in a long-standing uptrend takes that uptrend vertical. The vertical leap in prices preferably comes with sagging momentum, although any stock with a vertical chart (barring M&A activity, FDA drug approvals or the like) will eventually give way to the laws of gravity and at least mean-revert. The steeper a chart's slope, the closer an eventual mean-reversion move is. For an example of this, just look at Apple (AAPL) in the second half of 2012.

Let's first have a look at the longer-term developments on a weekly chart of Honeywell stock. Dating all the way back to 2007, the stock's line in the sand has been around the $62 mark. That level has been tested numerous times as resistance since then, yet had never been seriously broken to the upside until late 2012. The stock broke above the $62 mark for four days in early November 2012, but didn't really last above that level until December.

Honeywell Stock Chart - Weekly
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Honeywell Stock Chart - Weekly

Closer up on a daily chart of the stock, the steepening slope off the summer 2012 lows becomes more apparent. After consolidating sideways for the month of February, the stock gained enough momentum to make new 2013 highs in early March, which is when it took its chart vertical. 

After making a new 52-week intraday high today, the stock now sits about 20% above its 200-day simple moving average, which historically is extended for most stocks.

Furthermore, for those familiar with Elliott Wave Theory, Honeywell stock is likely currently in its final wave 5 higher and, thus, should soon be seeing a mean-reversion move lower. 

Honeywell Stock Chart - Daily
View photos
Honeywell Stock Chart - Daily

The best part about the steep slope in HON is that, to a large degree, the stock is being lifted higher by chasers of industrial stocks on the back of the aforementioned record-breaking rally in the Dow Jones Industrial Average. In other words, to be betting on a mean-reversion move lower in HON is simply betting that the Dow will eventually see another down day.

Traditionally, for one of my gravity pull trades I like to see a weak daily candlestick, which would more clearly signal the timing of the ensuing price correction. This weak candle is thus far notably absent on any charts of HON, which simply means we must operate with a stop level above recent highs. 

Recommended Trade Setup:

-- Sell HON short at $73.50 or higher
-- Set stop-loss at $76.50
-- Set price target at $67 for a potential 9% gain in 4-8 weeks

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