In simplified terms, Sir Isaac Newton’s law of universal gravitation states that “what goes up must come down.” He, of course, was referencing physical objects, yet I often observe similar phenomena in the stock market. Consider just a few of the meteoric ascents and dramatic crashes in Green Mountain Coffee Roasters (NASDAQ:GMCR), Electronic Arts (NASDAQ:EA), Chipotle Mexican Grill (NYSE:CMG) and Crocs (NASDAQ:CROX), which I covered recently.
These moves in the stock market, however, are more of the mean-reversion kind, where investors get too giddy and push a stock up too much too quickly so that in the intermediate term buyers are exhausted. As a result, the stock must drop back to a zone where a healthier balance of buyers and sellers exist.
For a recent example, we don’t have to look very far, as trading action in Apple (NASDAQ:AAPL) has displayed exactly such a mean-reversion move. The stock had been in a nice and defined up-trending range from 2009 through 2011, but in early 2012 the stock went vertical and broke out of the channel to the upside.
In the second half of 2012, however, AAPL finally ran out of steam and has been in such a mean-reversion move to the downside ever since.
Any stock that rises too steeply too quickly is prone to these mean-reversion moves. There are some exceptions of course, such as takeovers or major FDA drug approvals.
A stock that has recently exhibited such a vertical move appeared on my radar late last week. Fibria Celulose SA (NYSE:FBR) had a nice yet steep up-trend from June through November, and in the first week of December it shot straight up and out of the trading channel.
The 35% rally from late October to early December also led to severely overbought levels on the daily charts, as displayed by the Stochastic and Relative Strength indicators (RSI).
Furthermore, since the recent move that seemed to defy gravity, three concerning daily candles appeared on the charts: first an inside day on Dec. 6 on massive volume, followed by two doji candles. A series of such candles in overbought conditions following a vertical move in FBR sets up a good risk/reward short-side opportunity.
Short FBR at current levels. With a defined stop-loss levels at the highs from Dec. 5 near $11.60 and a target around $10.50, this is a clearly laid-out mean-reversion setup.
Beyond this immediate mean-reversion move to the downside, the stock remains in an up-trend that could get the stock up to $13.50 in time. Hence, once the stock has consolidated somewhat to the downside, profits should be taken before FBR begins another move up.