Green Mountain Coffee Roasters (GMCR) has seen more swings than a playground during the past two years. Last week, the stock took an already steep ascent vertical as it rallied hard. As a result, GMCR has bumped into a key area of resistance on the multi-year chart, which could be setting the stock up for a high-probability, short-side swing trade.
GMCR rallied more than 250% from January 2011 up to the peak in September 2011. But by mid-November of the same year, it had given up most of those gains -- a perfect example of a stock succumbing to the laws of gravity. GMCR may be an extreme case, but it illustrates exactly why traders should not chase vertical rallies or short vertical drops off a cliff.
In the latter half of 2011 and the first half of 2012, the company was in the news as rumors spread about the firm's accounting practices, which the media used to stir up quite the commotion. Traders on both sides of the stock got whipped around, and many likely learned their lesson about getting involved in a stock when emotions are running wild.
GMCR finally found its footing in late July/early August near the $17 mark and started to rally along with the broader stock market. From that low through today, the stock is up a whopping 365%.
Now, the vertical rally in the past five trading days has taken GMCR into a crucial and potentially last area of resistance on the weekly chart -- the 61.8% Fibonacci retracement of the entire slide from the September 2011 peak down to the summer 2012 lows. The most probable course of action is for the stock to take a breather here.
Closer up on the daily chart of GMCR, we can better see the recent vertical leap, which is what drew my interest to look for a defined short-side trade setup in the stock.
As it stands, the stock is 50% above its 200-day simple moving average, which historically means it is extended and should lead to some sort of a mean-reversion move lower sooner rather than later.
The recent rally came on the back of the company's latest earnings announcement on May 8, and a further alliance with Starbucks (SBUX). On Tuesday, the stock rallied strongly intraday, but gave up much of the gains by day's end, leaving behind a bearish shooting star candlestick with a long tail above its body. A follow-through selling day to confirm Tuesday's weakness is what we want to see for our short-side trade setup.
Recommended Trade Setup:
-- Sell GMCR short on a daily close below $77
-- Set stop-loss at $81.50
-- Set initial price target at $70 for a potential 9% gain in 2-4 weeks