Shares of healthcare services company UnitedHealth Group Inc. (NYSE:UNH) have surged after this week’s earnings results, adding to an already steep run. However, UNH stock increasingly looks overbought, and active traders and investors could consider UnitedHealth from the short side for a mean-reversion trade.
When UnitedHealth reported its fourth-quarter results on Wednesday, it beat expectations on both the top and bottom line and gave promising guidance for 2015. UNH earned $1.55 per share to beat estimates by a dime, and revenues of $33.43 billion just cleared expectations for $33.11 billion. All told, profits grew 10% year-over-year while sales improved by a respectable 7%.
And for next year, UnitedHealth is projecting earnings to come in a range of $6 to $6.25 per share of UNH stock, which is better than the consensus mark of $6.17.
In terms of price action, the broader healthcare sector continues to look strong, but many single-stock names are looking significantly overbought — and UNH is one of them.
UNH Stock Charts
One of the key things I like to look at through the lens of technical analysis is the slope of the line, or the rate of change. Slopes that are too steep almost always lead to a significant mean-reversion move lower. And stocks that rally strongly on top of an already steep slope (i.e., take a slope vertical) are very vulnerable to sharp mean-reversion or consolidation moves lower.
Case in point, if we look at the chart of UNH stock stretching back to the 2008 lows, we see a stock that over the years has taken an orderly incline and shaped it into a vertical chart, with the significant steepness having taken place since October 2014. From a momentum perspective — as represented by the Relative Strength Index (RSI) at the bottom of the chart — while no negative divergence is present, the indicator is deeply overbought, and at the very least, adding to or legging into major new long positions in the stock makes very little sense here.
Empirically, a steep slope like this could rather quickly flip to a 15% to 20% decline, which in the case of UNH stock would get it back into the low to mid-$90s.
On the daily chart, we see that UNH stock over the past two days has rallied more than 7%, which from a slope perspective could well be the overshooting on the upside that is needed for the stock to mean-revert lower in coming weeks.
When stocks have steep slopes such as UNH I like to use the eight and twenty-one day simple moving averages (blue and yellow lines respectively) in order go gauge immediate to near-term overbought readings. Very simply, when a stock is well above those moving averages in a steep-sloping stock, the stock likely has gone too far and needs to pause.
Active traders and investors could now look out for the next bearish reversal day in UNH, and a daily close back below $111.50 could set up a short-side trade for a move back toward $102 for a first price target.
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.
