In general, I try to avoid writing about stand alone short-term technical setups in these pages, for two main reasons. Firstly, I don’t believe that the majority of readers are looking for intra-day opportunities. Your presence here suggests an active role in managing your money, but, from feedback I have received it seems that opportunities with 3-12 month time horizons are more useful to most than those where it is measured in minutes or hours. Secondly, and maybe most importantly, by the time anybody actually reads the piece any short term opportunity based on a technical signal has probably gone.
What I do look for is proximity to established levels of support and resistance that can set up a trade with a good risk/reward ratio. Of course, that in itself isn’t enough. Given the 3-12 month time horizon that I try to work in there also has to be some fundamental reason that will give support to the stock. When those two come together, a trade can be suggested that uses some of the techniques of short term traders to benefit long term investors. Such is the case right now with the auction house Sotheby’s (BID).
First, let’s look at the technical case, or, more accurately as it is not particularly technical, the chart-based case.
As you can see, after bouncing off of support formed by the previous resistance around $39.30, BID dropped back towards that level last week. There are two ways to look at that, and the fact that they produce opposite conclusions indicates one of the main reasons that I distrust analysis based solely on technical factors. You could say that the proximity to that support level (strengthened by being significant three times) makes BID worth buying. On the other hand, this whole chart could be looked at as the formation of a giant head and shoulders pattern in which case, after a short period of consolidation, the most likely next move is a dramatic drop in the stock.
Depending on which way you look at it, then, the same chart can be used to support either a buyer’s or a seller’s case. Ultimately, which of those you believe depends on the fundamental, qualitative case. The thing about qualitative analysis though is that, by nature, it involves predictions and opinions and, to a large extent, guesswork. This unscientific approach means that you will be wrong at least part of the time and should have a plan to cover that eventuality; stop loss levels should be set at the time of trading.
So, in an ideal world, then, we are looking for a trade with a solid fundamental case, a logical stop loss level close by and an opportunity to place a risk-controlled trade. BID offers just that. Weakness in the stock is understandable, as Sotheby’s have missed street estimates in their last two earnings releases, but the art business in general is still in a period of strength. In the particular case of Sotheby’s, Daniel Loeb’s addition to the board could be a catalyst for change and a more focused, profit centered vision. Also, in the very short term, Sotheby’s will hold their Contemporary Art Evening Sale, a traditional area of strength for the house, on Wednesday. Any good news coming from that sale would give a boost to the stock.
These three short-term factors could drive BID higher and set up the kind of low risk trade that I talked of earlier. Assuming that you buy the stock at around Friday’s close of $40.67, then it should be done so with two levels in mind, each around 10% away. A stop loss around $36.50 would guard against a bad result from Wednesday’s auction and limit potential losses, while an initial target close to $45 should be watched. If that target is reached, then selling half of your position and leaving the stop loss in place for the remaining holding would leave you with a risk-free position at that point.
If things remain neutral over time, Loeb’s focus on a more efficient business will likely pay dividends and a more gradual, fundamental rise in the stock price can be expected. In this case, the reduced volatility makes just holding on to the position and moving the stop loss up to around the original entry level a better way of managing the position. Either way, if there is no sharp move to the downside, you should be able to set up a long term position in BID with little or no downside risk.
One of the things that I learned very early in my trading room career was that just picking short term winners wasn’t enough. You have to have a plan as to what you are going to do with them when either the plan worked or failed. After a while this leads to sometimes backing into a trade, where the setup suggests a plan before you even consider any fundamentals rather than being used to support and inform a basic case. This was the case with BID. The chart pattern suggested a possibility of a low risk entry and then the fundamental situation suggested upside potential. Put them together and you have a trade that makes sense.