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This Is Why I Shorted Microsoft

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J.C. Parets is the founder and president of New York based hedge fund Eagle Bay Capital, LLC. You can find his smart commentary at AllStarCharts.com.

Trades don’t get easier than this one. I like clean charts with clean entries and well-defined risks. Microsoft (MSFT) has all of those.

To start, here is a weekly chart showing the October 2007 highs at $37.50 before getting crushed. The stock lost 60% of it’s value over the next 15 months or so. After being boring for a while, it finally got a little rally, but only back to the 2007 highs. Now that everyone is excited about it (92% bullish sentiment according to Stocktwits) – I think it’s an obvious fade:

So now that we know it’s something we want to short, it’s all about the entry and defining the risk. On Wednesday MSFT was able to temporarily rally above that key $37.50 level from 2007. But as prices inched higher, momentum was already rolling over. Here is a short-term look using 10-min bars. Look at the bearish divergence between price and the Relative Strength Index plotted below.
We have an easy out. I can’t put a new position on unless I have well-defined risk, no matter how much I love the trade. In this case, I think you’ve got options. You can use Wednesday’s highs as a stop or you can wait until we’re below 37.50 and use anything above that as the stop. You can even use the Wednesday morning pop highs in the 37.70s. It really all depends on your risk tolerance and time horizon.

Easy trade. Right or wrong I can hold my head up high knowing that we got a good entry point with an extremely advantageous risk/reward ratio. That’s all I can ask for.

[For the other side of the Microsoft trade, click here.]