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Trade of the Day: The Bearish Reversal in Caterpillar Inc. Constructs a Trade

Serge Berger

While the broader market acted weak on Tuesday and technology stocks didn’t help matters, it was the industrial sector that led the charge lower. Shares of Caterpillar Inc. (NYSE:CAT), a major industrial stock, dropped 6.2% on the day after the company’s remarks in the post-earnings call failed to impress investors. As a result, CAT stock left behind on the daily chart what we refer to as a bearish reversal day that now, I think, calls for further weakness in coming weeks.

It is always interesting to hear the financial media discuss a company’s earnings report and dissect the past quarter’s top- and bottom-line performance. Ultimately, however, what really moves the stock more often than not is the outlook. Caterpillar uttered some cautionary words during its outlook and that was what got the stock’s investors nervous.

Caterpillar Stock Charts

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Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week

Looking at the multiyear weekly chart of big kitty, we see that as a result of the steep second half 2017 ascent CAT stock by the second half of January 2018 had reached the upper end of its big picture up-trend for the first time since the year 2011.

This also shot the stock into serious overbought territory as measured by the MACD momentum oscillator at the bottom of the chart. It is those inflection points that most often at the very least lead to sideways consolidation in a stock before a next leg higher can take place.

In the case of CAT stock, it now looks like more of this consolidation, possibly lower, is in the cards.

Click to Enlarge

Moving averages legend: red – 200 day, blue – 100 day, yellow – 50 day

On the daily chart, we see that after topping out in the second half of January along with the broader stock market (remember, stocks are a highly correlated asset class) CAT stock began chopping back and forth in a fairly wide range, snapping its 50- and 100-day simple moving averages but so far holding the red 200-day. The stock now has well-defined support around the $140 mark, which is where the 200-day coincides with simple horizontal support as marked by the blue bar.

Tuesday’s post-earnings price action shows that the stock initially rallied but then quickly faltered. The stock reversed gears so much on an intraday basis that the day’s candle fully engulfed the past two week’s price action. This is called a bearish outside day, and from where I sit it should lead to more weakness in the stock through a multiweek lens.

There are multiple ways to play this stock now, but one way would be to simply short the stock at current levels or buy at-the-money puts or put spreads with at least two months left to go (so that theta doesn’t hurt too much) with an initial downside target at $130. Any significant one-day bullish reversal should be respected as a possible stop loss signal.

Check out Anthony Mirhaydari’s Daily Market Outlook for April 25.

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