Limited-Time-Only Abercrombie Trade

04/20/2011 8:00 am EST

Focus: STOCKS

Corey Rosenbloom

Founder and President, Afraid to Trade

Shares of Abercrombie & Fitch may retrace a bit before potentially beginning a new wave higher. There’s one key level to watch now, and traders regardless of risk profile should find set-ups they like.

Popular retailer Abercrombie & Fitch (ANF) has recently made it on to my radar as a stock that has run away from its 200-day moving average.

For anyone who trades a “reversion to the mean” strategy (or as I like to call it, “what goes up must come down”), it is worth checking out.

Indeed, looking at ANF on a longer-term chart, it is at a critical pivot or turning point that will determine whether this strong power rally continues, or as the chart suggests, takes a slight/small breather here into a critical weekly resistance level.

chart
Click to Enlarge

Cutting right to the point, the $70.00-per-share level is the key bull/bear battle as the chart stands right now.

Why?

First, it’s a simple, round-number level, and if you look closely, ANF has had difficultly popping through each of its major round-number digits on the way up.

Look at the pullback from $40 per share in late 2009; from $50.00 per share in April 2010 (the “flash crash” period); and just recently in 2011 at $60.

Of course, once buyers powered through these overhead levels, the stock burst impulsively higher each time, including the recent surge above $60.00 to $70.00.

Second, the $70.00-per-share region was the midpoint, or “value area” (congestion area) of the peak, or “rounded reversal” structure in 2007 into 2008.

We would call this a “supply area” and could see resistance because of that (buyers selling shares/distributing once they get back to breakeven, assuming they’ve remained holding long until present).

So the main idea is to watch the $70.00 level closely, with very aggressive traders considering a potential short-term retracement/reaction down from here (tight stop above) while traders who are long might want to view this area as a potential target for taking profits.

The calculus would change dramatically on a surge above $70.00, of course, so that’s why this level is important.

NEXT: See Daily Chart and Prepare Your Strategy

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With that in mind, let’s take a look at the daily chart:

chart
Click to Enlarge

As I mentioned before, Abercrombie is quite extended above its 200-day simple moving average (SMA), up 44% above its long-term average around $47.50.

Doesn’t that big surge up in early April just scream pullback?

Maybe, so let’s look for logical targets should buyers begin taking profits along with bears shorting into the $70.00 level.

The first, or immediate target, would be $65.00, which is the rising 20-day EMA (a logical target in a stock that’s overextended and rising), but under $65.00 sends us back to the critical pivot at $60, which is both the round-number and price resistance area, along with the rising 20-week exponential moving average (EMA) now around $57.00.

New price highs along with new momentum (and volume) highs tend to precede new price highs yet to come after an initial pullback/retracement.

This forms the foundation for retracement strategies, namely, the “impulse buy” or many bull flag patterns you trade.

So, if the principle holds true, we can expect a pullback to be the next phase that could lead to a buying opportunity as the current retracement—which seems likely—finds support either at $65.00 or $60.00 (depending on what happens in the next week or so).

That would set us up for a re-challenge of $70.00 and then a potential breakthrough of that level.

Very similar logic played out in ANF regarding the price/volume and momentum surge/impulse in December 2010, with a pullback into support (trend line) at the end of January 2011. This retracement buy-in took the stock back to $60 for the eventual breakthrough/breakout in April.

Even if you don’t trade Abercrombie & Fitch, the stock chart does provide some interesting lessons in a powerfully trending stock, impulse set-ups/retracements, and of course breakouts (from round numbers), which many traders find difficult yet rewarding.

By Corey Rosenbloom, trader and blogger, AfraidToTrade.com

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