Many traders now understand thatbuy-and-hold strategies can
suffer from steep losses for years at a time. This knowledge was
probably acquired from expensive first-hand experience. In a
strongbull market that lasts for decades,buy and hold is a
soundinvestment strategy. But in a long-termbear market like the
one that has provided the backdrop for stocks since 2000, it is
usually better to take profits when long-term sell signals
Major stockmarket averages, like the S&P 500, have recently
fallen below their 200-day moving averages (
). Some have rebounded above the average, but throwbacks after a
trading signal are common. A throwback occurs when the price is
"thrown back" through the signal and generates short-term trades
while the direction of the long-term trend is resolved.
Breaks of the 200-day MA, even with throwbacks, are often a sign
that the long-term trend is changing. In this case, we could see a
large price decline develop during the next several months. In an
environment like this, it is important to take profits when the
chart gives a sell signal like it is in
The Coca-Cola Company (
Coca-Cola is one of the classic examples of a buy-and-hold
stock. It is one of the largest companies in the world with steady
sales from a product that is among the most recognized brand names
in the world. Itsdividend is considered to be safe and the stock is
a favorite of income investors, while long-term investors have been
well rewarded by the company. In the bull market that started in
1982, Coca-Cola gained more than 5,500%, plus dividends, but since
reaching its all-time high in 1998, it is down about 16%.
Now, Coca-Cola has formed a head-and-shoulders (H&S) pattern
and fallen below its200-day moving average (
). In the chart below, the 40-week MA is shown because the pattern
is easier tospot on the weekly chart. The trade strategy is the
same whether a weekly or daily chart is used.
In a H&S pattern, three peaks are seen at the end of an
uptrend. The head of the pattern is more than 115% above the lowest
price Coca-Cola reached in 2009. The pattern suggests the end of
the trend in Coca-Cola is coming at the same time the general trend
in the stock market is turning down.
It is also possible that Coca-Cola, and other stocks favored by
buy-and-hold investors, could come under pressure fromtax selling .
As a classic buy-and-hold stock, many shareholders in Coca-Cola
have probably held their positions for years.Taxes on long-term
capital gains are slated to rise next year no matter how the
current negotiations over the fiscal cliff end. Because of the
higher tax rates to come, some long-term investors may decide to
take gains this year and free up capital to put into faster growing
Even without tax selling, Coca-Cola seems destined to fall at
least 10% based on the chart pattern and should reach $32 a share.
That target is obtained by finding the distance from the top of the
head to the neckline in the pattern and subtracting that from the
In a larger stock market sell-off, the price could go even
lower. Coca-Cola seems like a short trade candidate, but the
dividend makes shorting the stock expensive. When you short a
stock, you borrow theshares that you sell from yourbroker and are
liable for the dividend payments in addition to other costs related
to borrowing the stock. Given the high costs, aput option strategy
could be more profitable.
February $35 puts are priced at about $0.43 and would be
profitable if Coca-Cola falls below $34.57, about 7% below the
recent price. At the target price of $32, the puts would be worth
$3. This is a low-priced way toprofit from the H&S pattern in
Coca-Cola and a possible market decline.
Action to Take -->
Buy Coca-Cola Feb 35 Puts at $1 or less. Set stop-loss at
$0.25. Set initialprice target at $3 for a potential 200% gain
in three months.
This article originally appeared on TradingAuthority.com:
Sell-Off in Classic Buy-and-Hold Stock Could