Trading the Trend (long and short) - Foxtons and Royal Mail

Shorting is a contentious issue in the investing community. Many view it as evil, and others view it as a necessary balance in the market. After all, if everyone was only allowed to go long – then who would keep rampant bulls in check? And that is exactly why China is taking steps to limit short selling today on February 3. Whether that continues after this is currently unknown.

But many investors use shorting to hedge risk, and I believe it allows a certain fairness in the market, with other people being allowed to take the opposite side of trades.

Whilst I certainly don’t agree with a broker’s market making desk shorting the stock and then having the same broker offering the company money in an attempt to close that same short position (value destruction), shorting is healthy (despite one prominent CEO on Twitter calling for it to be banned). It will certainly be interesting to see the outcome of China’s experiment.

Foxtons

Foxtons is an estate agent which has had a rough fall since initially rising from its IPO. The price almost reached 400p, and then steadily crumbed for a multi-year period, before appearing to put in a low just below 50p.

It’s a stock that – alongside Countrywide – has been the attraction of many shorters (myself included). Revenues were down 4% year-on-year in the recent trading statement, but the company no longer looks like it is going to be in extreme difficulty.

This may be the reason for the recent rise.

Or it may not be. It still looks like a low quality business to me, but looking at the chart we saw volumes in the stock increase in July as the stock put in its recent lowest low. The only reason volumes could’ve increased is if buying interest was sufficiently there to clear the sellers and push the stock upwards.

Since the start of September, volume has also been increasing and the stock took out its recent high, with a breakout on good volume. The stock is holding that level, and so I intend to start watching Level 2 closer here. Is the stock well bid? Are there consistent icebergs reloading any AT sells? Even without Level 2, the beauty of the chart is that it tells us what is going on already as the bull flag is forming.

One issue of going long on the breakout is that the 200 moving average is just above the level I’d look to buy. It’s going to act as resistance, so it’s worth being aware of that when deciding the risk to employ on the trade. It’s no good having a 2:1 reward to risk ratio if resistance is clearly going to get in the way of that. We’re trading the market, and not the other way around – imposing our own reward to risk ratio on it is foolish because the market couldn’t give a damn about yours or my reward to risk ratio.

It's also worth noting that as in previous articles, the StockRank looks very similar.

Momentum is a key factor again. Stocks with a high momentum rank are clearly trading opportunities on the long side.

Royal Mail

Royal Mail has also had a turbulent time in its listed history too. The company issued a profit warning which dented the value of its stock in July 2018. Since then, it has struggled to perform, with the stock languishing around all time lows.

I haven’t followed the fortunes of this business, but the StockRanks offer it a high rating.

Quality and value are very high, with momentum trending lower. This is good, because I see the stock as offering a potentially good short entry.

The stock has put in support that has been tested several times since the start of last summer. Each time it’s held, and the stock has rallied, only to come back and test the support. We can see that many times price went below the support line (where many stops will have been gunned down) only for the price to rebound. Price will go where liquidity is, and there is sure to be liquidity directly on and just underneath the support line. Anyone placing their stop just below support can expect to be taken out.

What this chart tells us is that so far support has been significant. That means if, or when, it does fall – that the price is telling us that something significant is happening. One could argue that the chart also represents a long trade, from buying just underneath support – and that’s a fair argument. Historically, price has rebounded and rallied, but it always came back to test the level on the line.

The price also failed to punch above the 200 moving average which is key to note.

In my opinion, there is a good probability of an extended move should the Royal Mail stock price breach this key level.

Looking closer, we can see the volume increase when the price trades close to this zone. It’s a battle of bulls versus bears. Eventually, one party will run out of firepower and a new trend will be established. I wouldn’t be interested in trading Royal Mail long – mainly because it’s in a downtrend but also it’s too big. At nearly £2bn market cap the company would need to add £400m of value just to increase 20%. Whilst the stock market doesn’t always correlate the value, when it comes to large caps the market is generally a lot more efficient, and lacks the volatility that traders need unless we lever ourselves up and/or trade intraday moves.

If this chart was of a smaller company, I’d want to see the share price take out the both the 200 moving average and the high at 258p. This is because of the long and protracted downtrend – I’d need to see price action do something significant to convince me that the trend may have changed.

Two consecutive closes below the line identified, or a breakdown from 190p would convince me to go short here.