Looking at Lehman LEH

Sep 11, 2008: 3:05 PM CST

Financial company Lehman Brothers (LEH) has been under intense media scrutiny due to the recent price plunge and charges of potential financial instability.  Let’s look at the chart structure from 2006 to today and see what clues may have been evident, or how you could have managed risk in this stock.

LEH Weekly:

The larger structure shows that early indications of an impending downtrend began in mid-2007 with price breaking the 20 and 50 week EMAs which had been support.  Also, price formed a lower high and then formed a lower low when price tested the rising 200 week moving average.  Remember that after an uptrend when price is ‘shifting gears,’ price will fail to hold at the 50 period EMA which will then often set-up a test of the 200 period SMA – this was exactly the case in LEH.

While it seemed that the 200 week SMA would hold – and in fact it did so throughout the latter part of 2007, weakness was evident because price could not rise above the confluence of the 20 and 50 week EMAs just above.  With price consolidating into a rectangle formation, the odds of a downside break were higher than that of an upside one.

In fact, this happened in early 2008 (January) but price immediately rose up quickly to test the falling EMAs in a ‘last breath’ sign of desperation.  From this price near $65, LEH never looked back, and in fact plunged very rapidly to the downside before being crushed on the Bear Stearns announcement in March, which formed a massive recovery shortly after.

Still, despite this, price was only able to retrace to the falling 20 week EMA yet again, form a very clear doji reversal pattern at resistance (which was your highest probability signal on the chart), and then has yet again not looked back to the downside into the current price low at $4.00 per share.

From mid-2007 to present, the momentum oscillator has been registering lower lows and lower highs, confirming massive price weakness.

Let’s take a quick look at the daily chart for a closer view of the current action.

LEH Daily:

We see the March debacle a little clearer here.  Nevertheless, the 20 day EMA served as significant resistance, which also served as excellent short-selling entry points (or long liquidation points) into the prevailing and primary downtrend which was evident and confirmed on the higher time frame.

You could have position traded this stock by entering short virtually at any point, but I’ve highlighted the breakdown from consolidation at $40 per share as an optimum entry and then trailed a stop above the 50 day EMA for a profit or stop-loss.  Now might be a good time to exit immediately if you are using that strategy because you don’t want to see price potentially rocket up to $17 per share to stop you out – exit into capitulation or massive range expansion and move on.

Despite two positive momentum divergence (both of which gave decent upside percentage moves), these weren’t enough to turn the stock in any meaningful way.

Lehman will serve as an example that it’s quite unprofitable to attempt to catch a falling knife sometimes (where exactly was the bottom again?) and that it can be very profitable to trail a stop into a prevailing trend (short or with put options).

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