GMCR Watch

I just watched Fed Chairman Bernanke at a town-hall meeting of soldiers and military families. Great questions and excellent answers, but Bernanke -- poor man -- has the verbal habit of saying “obviously” every chance he gets. It sounds a bit arrogant.

Of course, I’ve always been a big fan of arrogance -- arrogant people seem so calm and self-assured -- and that's the sort of arrogance I'm striving for in a measured response to a selling panic impacting a mainstay of my portfolio. Obviously.

Green Mountain Coffee Roasters Inc. (GMCR) is trading 37% below Wednesday’s close, making it the bad boy of my portfolio.

sym	phase	trend	adx		200/50	40/10
GMCR

I not only own GMCR shares, against which I had sold October covered calls, but I also opened a bull call spread, expecting a rise after a price dip. The market in GMCR did not move as I had anticipated. I miscalled it.

But, the motto of the private trader is "Never panic. Read the charts." The GMCR chart shows that the decline is well within the expected behavior for this stock.

GMCR since Sept. 20 has been trading within a downtrending channel, with a ceiling today of about $68.60 and a floor at around $47. Which, coincidentally, is where GMCR opened after an overnight gap that carried the price from the ceiling of the channel to the floor. After the open, GMCR has fallen further. But the big movement at the open was not a channel breakout.

The decline from the open has brought the price down to $40.40 (so far), a level last seen during a long-running sideways move in March from which the uptrend to the $115.98 peak in September began. The stock has retraced 100% of its rise.

Despite the extreme nature of the move, GMCR is still honoring support levels and has recognized channel boundaries. It's a big one-day decline, but not a rout.

Wednesday's average true range for GMCR -- the 10-day average daily movement of the stock price -- was $5.71. The decline from Wednesday's close to Thursday's open was $20.02. So the overnight gap was equivalent to 3-1/2 days' movement in the price. Not the stuff of tragedies.

None of that is intended to minimize the blow to my portfolio. I'm feeling the pain. But in context, it's not a coffee-roasting apocalypse.

As a trader, where do I go from here?

GMCR's earnings announced Wednesday after the close missed the estimate to the downside by 1.3¢. It is said the rising inventory and changes in customer ordering caused a loss of investor confidence.

On the other hand, historically, stocks that move that far that fast end up rebounding to a certain extent, and certainly GMCR could eventually return to the prior peak. Yes, expecting a 187% rise seems unreasonable, even arrogant. A rise that is worth 21 days of average price movement -- the same rise as 187% -- seems well within reach.

So I'll continue to hold the shares, as zombies -- meaning I'm not selling covered calls against them -- until I see a recovery to near my entry level. I'll also continue to hold the bear call spread, which expires in 10 days, on the guess that there will be a rebound that will mitigate my loss at least slightly. But I'll watch the chart closely, and exit the options if things start to worsen dramatically. Another downward gap, for example, would send me running for exits.

The main take-away from the GMCR gap is the importance of position sizing. I have limits on my holdings. No option holding can exceed 1% of my total trading funds. No stock holding can exceed 4%. So even if I were to cash out now, at the bottom (I hope) of the selling panic, I'd feel the pinch, but I would not be bloodied by the experience.

Position sizing is paramount on the road to successful trading. Obviously.

Key

• phase: 20-day price channel phase, with green for bull trend, red for bear trend and yellow for neutral trend.
• trend: Price direction, green for higher highs and higher lows, red for lower highs and lower lows, yellow for sideways, and grey for neutral or ambiguous.
• adx: Average directional index location, indicating the strength, or the temperature, of the trend. Orange for 40 or greater, aqua (light blue) for 25 and up but below 40, magenta (light purple) for 20 and up but below 25, and brown for anything below 20. (Mnemonic: Orange for the overhead sun, blue for the surrounding sky, magenta for sunset on the horizon and brown for the earth.)
• 200/50: The moving average cross, green for the 50-day ma above the 200, red for below and yellow for closely aligned.
• 40/10: The moving average cross, green for the 10-day ma above the 40, red for below and yellow for closely aligned.

About my trading methods

Read a detailed explanation of my analysis method, including trading rules.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

The trader’s greatest sin is inaction. Sleeper, awake! Seize the Nietzchean moment. Roll out of bed and trade.