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Trade of the Day: Chico’s Fashion (CHS)

Waning bearish pressure may mean CHS is ready to rally

   

Despite wary consumers, despite stagnant wages, despite less-than-stellar same store comps and revenue growth in many corners of the industry, retail has chugged along. The SPDR Retail ETF (NYSE:XRT), is up 19.5% YTD. Lumped all together, it is easy to assume good fortune in the entire sector. But for investors in individual names, retail has either been a renewed love affair or a frustrating exercise in watching your neighbor’s grass get greener while yours seems to wither.

Chico’s Fashion (NYSE:CHS) sits somewhere in the middle: its performance hasn’t made investors want to kiss their quarterly statements but neither has it been exasperating. With the market’s six-month trend looking almost too textbook, and perhaps showing a bit of complacency, it may be beneficial to look at a stock whose volatility and trading range are almost quaint.

Could CHS’s Chart Be Changing?

While the market has been busy setting all-time highs, CHS meandered through a gradual downtrending channel over the last seven months. While the loss hasn’t exactly been earth-shattering – the pattern took CHS only from a high of about $19.64 to a low of $16.17 – it has caused impatience among investors who have watched stocks like Michael Kors Holdings (NYSE:KORS), The Gap (NYSE:GPS), The TJX Companies (NYSE:TJX), Urban Outfitters (NASDAQ:URBN) and other retailers do a better job of capitalizing on the broad market’s bullish run.

Could that be changing? CHS is showing signs of crossing the upper end of its channel and testing a resistance level at about $18.10. Although still at a pivotal juncture, the recent action has been bullish as the stock has made a series of higher lows over the last two and a half months, indicating that a reversal of the downtrending channel may be underway.

Volatility-wise, CHS is a low-risk stock with narrow trading ranges. Even a move back down to the low end of the channel would take only $1.5 off the price of the stock. For that reason, entering at the current price in anticipation of a change in trend direction comes with low risk. For example, CHS saw a retraced breakout to the downside at the end of February. The price broke down through support on heavy volume but quickly recovered and raced back towards the top of the channel. If a similar mirror-image false breakout were to happen here, placing a stop midway into the existing channel risks only $1 of downside.

An upside breakout would likely put CHS into a new trading range with $18.10 as new support and $19.50 – 19.75 as the upper end of the range. Failing the breakout would keep CHS in its current range with $18.10 as a strong ceiling and roughly $16.75 as support.

5 8 13 chs 1 1024x572 Trade of the Day: Chicos Fashion (CHS) 5 8 13 chs insert 1024x580 Trade of the Day: Chicos Fashion (CHS)If the momentum behind CHS’ current rally fails to propel it to this new higher range, expect the stock to fall back down to the $16.75 – 17.00 level. For a long-term minded investor, this would represent a technically valuable entry price. The $16 level is significant – prior to August 2012 it was very strong resistance but its break through has been a game-changer for the stock. The short-lived breach of the channel support just mentioned was quickly and resolutely reversed because the stock tested this long term support level. A price in the sub-$17 range would be well protected to the downside with this support.

5 8 13 chs 2 1024x572 Trade of the Day: Chicos Fashion (CHS)

Bullish Sentiment? Look to the Short Sellers

After a stock makes a run to the upper end of a trading range, a decisive question for traders watching the technical action is whether the stock can maintain sufficient bullish sentiment to break through resistance and whether an upside break can hold. The cyclicality in sentiment often disguises itself for a time, sucking in early commitments from breaks in support or resistance only to claim victims once sentiment changes. So one way to determine if bullish sentiment is running out of steam is to check short seller data. After a bullish run, especially within a defined trading channel, one would expect short selling to accumulate towards the top of the channel, indicating that bearish sentiment is gaining confidence.

However, if there is significant short covering after a bullish move, this points to a lack of conviction among sellers and hints that more upside may be expected. This is what CHS has seen. Shares shorted have fallen from 8.57M at the beginning of March to 6.56M at the beginning of April to 5.82M currently. This amounts to a 3.5% short interest, certainly insufficient to spark any kind of a short squeeze but also indicative of waning bearish pressure. And with the bears getting worn out, perhaps it is CHS’ time to join the retail party.

Recommendation:  Buy the breakout below $19.50 per share.

Option alternative: Buy the August 19 Calls for $1.50 or less.

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