Most losses stem from obvious mistakes. Chasing a stock after a giant rally is an obvious mistake — it leaves investors vulnerable to disappointment. American Airlines (NASDAQ:AAL) shot up, and many learned about this disappointment the hard way. AAL stock has fallen this week, but its problems started a long time ago.
Much of this drama started in early June, when experts started calling for a rally. Unfortunately, shares have fallen 40% from highs set on June 5. That was around the time when CNBC began focusing on Robinhood investors and their quick profits on airline stocks. But these bullish investors overstayed their welcome, and profits turned into losses.
There are simple rules investor must be willing to follow, and there aren’t any real shortcuts. You must understand macroeconomics. Then, you must study a stock’s fundamentals. Compare companies to their competitors — in this instance, Delta Air Lines (NYSE:DAL) and United Airlines (NASDAQ:UAL). Lastly, I am a strong believer in the charts, so I never make a trade without studying levels and patterns.
Why do charts matter? Well, in an age where most trading is done by machines, the technical aspects ring truer than ever. Machines only trade based on history, and history is exactly what you see on the chart. Understanding the price history also means you can predict potential pitfalls.
Things Are Tougher Than They Seem
The big picture is terrible. Millions of U.S. residents are out of work, but the stock market doesn’t care. There’s even chatter of a second round of stimulus checks coming from the White House. Meanwhile, there is underlying weakness for American Airlines. The Transportation Security Administration traffic reports still show the daily airline throughput is down 78% year-over-year.
This is hardly supportive of the bull case.
Now that we have established that the environment is still hostile for airlines, we must look at what upside potential AAL stock has. I can report that, so far, it is packing its planes full. It could be worse. I know this because my wife just flew to and from Texas, and both of her flights had zero empty seats.
Eventually, airlines will have to comply with new capacity rules. These rules will add to their burden. This sounds ominous, but it is important to thoroughly stress test every bullish thesis.
There Is Good News for AAL Stock
I promise you that I am not a hater. In fact, I shared a bullish write-up on March 31 calling AAL stock a “bargain buy.” Even though I didn’t nail a perfect bottom, that trade saw shares nearly double. Now, the stock is falling back into the clutches of those March levels. But, remember that it’s normal for a stock to revisit the base from which it rallied.
The rally that started June 4 was too steep to last. Now, ownership will transfer into better hands, which will help shares inch higher in a more sustainable way. Buying shares now makes a ton of sense — for both long-term and even mid-term investors.
I prefer selling puts or put spreads into the support area near $10 than bet on upside hopium. This way, I can generate profits without even needing a rally. In fact, the stock can fall another 30% before I would lose money on this trade.
Fret the New Normal for Crowd Economies
Crowd economies are now at a severe disadvantage, and airlines are at the center of the problem. Until we have a vaccine, many consumers won’t have the courage to fly. And some won’t even visit brick-and-mortar retailers. I personally now avoid Home Depot (NYSE:HD) and Costco (NASDAQ:COST), even though I frequented those stores for fun prior to the novel coronavirus.
Things may have changed forever, but I am optimistic. We may simply need time to heal.
Airlines will soon have to make big strategic decisions that will have consequences for their future success. The bottom line is that they are on life support. They are taking on more debt, digging deeper holes just to have cash. Yes, they need to do this to survive 2020. But this means expecting sharp upside rallies is not logical, because it assumes an overnight change in the airline situation. At this point, such a change is impossible.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
