Case Study: When a Stock Rally Cools Down

Stocks rise and stocks fall - this we all know.

The tragedy is that the prevailing belief on Main Street is that you can only make money in the stock market if your portfolio holdings rise in price. This is among the greatest fallacies conveyed to the general investing public.

After all, most retirement funds only assume long positions in the market; their bias is to the upside, and they under-perform during market pullbacks.  

Unlike Main Street, Wall Street plays the game both ways - professional traders make money during rallies and sell-offs. The struggle between bears and bulls is zero sum  -  money never vanishes, it simply changes hands.

In this post, I am going to dissect the recent price action for CF Industries Holdings, Inc. (NYSE: CF) as a case study example of how to identify stocks as potential short candidates once strong price rallies show signs of cooling down. Per Google Finance, the company "is a manufacturer and distributor of nitrogen and phosphate fertilizer products worldwide."

$CF : CF Industries Holdings, Inc.

The chart above displays two time frames of interest: the daily and the two hour views.

As is obvious, $CF has had quite the rally since trading as low as $244.81 on 12/16. Having traded as high as $303.09 yesterday, the stock has gained nearly $60 a share in four weeks.

On the daily chart, the $300 level has shown itself to be a formidable resistance area. Bulls failed to close $CF above $300 on 1/9/15, 1/12/15, and yesterday, despite having flirted with or even exceeded the $300 level intra-day during all three trading sessions.

The 5 DMA is above the 9 DMA so the trend is still higher on the daily time frame. However, yesterday's close was the first in which the bulls failed to close the stock above its open price. $CF opened yesterday at $299.57 and closed at $299.24. For the prior five trading sessions, the opposite held true, as $CF closed above its opening prices.

A close below the 5 DMA, currently at $295.91, would be a first for $CF since 12/31, and could portend a further pullback in the near term. A congestion zone to watch for support on any sell off would be the $286/$287 area.

In looking at the two hour chart, we can see that +DMI has remained above -DMI since mid-December, indicative of the bulls dominating the price action.

However, -DMI is beginning to creep up, as bears have applied selling pressure in recent days around the $300 level. Should -DMI surpass +DMI, this would point to a possible sentiment shift in favor of the bears.

The ADX line is no longer rising, so the strong trending move higher may have abated for now, and a range trade could be in play.