Updated: Nov 24, 2020
Published January 10, 2018
Abercrombie & Fitch's ($ANF) stock price has more than doubled after posting a 52-week low of $8.57 this past summer.
Does this recent rally mean that Abercrombie & Fitch is making a comeback or is this company ultimately doomed for bankruptcy?
The monthly chart reveals more than one might think.
We are in the midst of the euphoric stage of the bull-market. Markets have been rallying all year and most stocks are at all-time highs. While, the average investor is busy chasing marijuana stocks and cryptocurrencies, you should take a step back and formulate a solid trading strategy that no one is considering. One simple strategy is to find companies doomed for bankruptcy that also happen to have benefitted from this recent rally in stocks and shorting them with both HANDS!
In one of my later posts I'll be listing many of these stocks and their charts which I refer to them as "bankruptcy charts" but for now let's focus on Abercrombie & Fitch.
Abercrombie & Fitch's monthly chart reveals the nature of this recent rally and perhaps the destiny of this company.
As a market technician I almost never rely on fundamentals to formulate trade ideas. Fundamental metrics such as financial ratios and earning projections have never helped me time a trade in my career.
In my opinion, one of the best ways to evaluate a company's fundamental story and predict its faith is to analyze its monthly chart. Using the monthly chart you can identify the primary trend and take advantage of the corrective-waves that form within that trend.
As you can see in the monthly chart below, Abercrombie & Fitch's stock price has been in a primary downtrend after making a high of $63.94 in July of 2011. This strong downtrend channel has shown no mercy to Abercrombie & Fitch, taking the stock price to an all time low of $8.57 in July of 2017. That is a staggering 86% decline!!! Now nothing speaks more truth than the actual price itself. This company has lost its relevance in a competitive space and it's in serious trouble. In fact, this company reminds me of Aeropostale which, filed for bankruptcy in May of 2016 but managed to keep some of their stores after landing a $243.3 million dollar bankruptcy deal.
Now I'm gonna tell you where the opportunity lies and how you can take advantage of it. As you can see in the monthly chart, the share price hasn't just declined 86% in a straight line. In fact, there have been four corrective waves within this downtrend channel representing amazing opportunities to short the stock. Stock price is currently in the most recent corrective wave, taking the price from low of $8.57 to current price of $19/share. That is more than a %100 increase in price!!! In my opinion, this recent rally represents an amazing opportunity to short this stock.
How should you short this stock ?
There are multiple ways of betting against a stock such as purchasing puts, shorting OTM upside calls or simply shorting the stock the old-fashioned way. However, when it comes to small cap companies I almost always advise against selling shares or even worse shorting naked calls. That is because possibility of some sort of a merger or acquisition is always there and you don't want to be holding anything short when that happens.
In my personal view, the best way to short small cap companies is buying long term ITM puts or LEAPS. This way you can properly decide how much money you are willing to risk before entering this trade.
The January 17, 2020 $20 puts are currently trading at around $5.60/contract, now if this primary downtrend resumes by January 2020, taking out the all time low of $8.57 you can double your money or even more!!! However, if the price continues to go up to the $22-$23 area, I would consider getting into the January 17, 2020 $22 or the January 17, 2020 $25 puts which are trading at around $7 and $9/contract respectively.
So when should you enter this trade?
Although the stock price has more than doubled in this recent rally, it might be slightly premature to short Abercrombie & Fitch. As you can see in the monthly chart above, the top downtrend line of this channel meets the stock price at $22-$23/share. In addition, price is pushing against the top Bollinger Band and it looks like that the bands are expanding pointing to further upside. With the momentum indicators such as Slow STO, RSI and MFI all approaching overbought territories, I would perhaps wait to see if the price manages to get to $22-$23/share before fully committing myself to short this stock.
How to protect yourself should you decide to short Abercrombie & Fitch?
Although shorting Abercrombie and Fitch might sound like an enticing idea, the recent bull market rally in financial markets particularly the retail sector must not be overlooked. Currently, we are in the euphoric stage of the bull market and stocks can remain irrational more than you can remain solvent.
The retail sector of the S&P500 has recently come to life after consolidating for nearly three years . As you can see in the monthly chart below, the XRT is trying to get out of this 3-year range and closing above all time high of $49.33 could further strengthen this possibility. Now if that happens, I would be looking to pick up some long-term OTM calls to protect my short trade in Abercrombie & Fitch.
The XRT January 18, 2019 $50 calls are currently trading around $3.50/contract. Should you decide to short Abercrombie & Fitch I would seriously consider picking up some OTM calls in XRT to protect myself against any further upside in the sector.