Estée Lauder a Short Play Following Pullback

The second half of 2016 has not been kind to The Estée Lauder Companies, Inc. (NYSE: EL).  Two consecutive quarters of revenue misses were enough to send the stock tumbling over 20 points.  Their recently announced acquisition of Two Faced for $1.45 Billion may have temporarily halted the slide, however the benefits of that acquisition will likely occur too late to prevent a deeper dip in the short term.

EL Daily Chart

 Notice on the daily chart a bit of a spike in volume at the 52-week high in late April.  The behavior of EL for the week leading into that volume spike hints at climactic behavior and the start of a distribution phase by market specialists.  Indeed, that appears to be what followed as we see the stock amble sideways for a good 3 1/2 months. 

The current downtrend for the stock started with a buying climax on August 18th (marked on the chart with "O".  Look at the volume signature on the 18th and 19th.  Supply was clearly abundant, and the stock had no place to go but down.  August 18th marks the start of the current 5-wave impulse.

Following the second consecutive missed revenue quarter, EL plummeted over 9.5 points in just four sessions.  Now, here's where the chart interpretations can get interesting.  We've marked the end of wave 3 on the chart with the low of November 16th, however that is by no means certain.  From the end of Wave 2, we can count three clearly defined sub-waves.  Wave 3 is a 5-wave impulse, so there should be more room to the downside to complete Wave 3.  We've played it safe in our current interpretation, but let's not be surprised if it's actually Wave 3 that continues, and not Wave 5. 

Although it's not shown on the chart, there's a very strong resistance level at the 76.4% mark around 81.33.  That would represent a 61.8% retracement of the current Wave 3 pattern, so we should be prepared for a pullback to that level before the downtrend continues.

The final piece of the puzzle is the Accum/Dist line below the chart.  This is a great indicator that shows whether or not shares are being accumulated (meaning there's high demand for the stock) or if shares are being distributed (meaning there's an oversupply of the stock.)  We can see from the slope of that line that supply has been overpowering demand, and there's no indication yet that supply has been exhausted.  In fact, today's 1.16% drop on high volume with a close at the low of the session suggests that there's plenty of supply remaining to push the stock lower.

Here's how we're playing this stock.

• If the stock breaks below 76.65 with confirming volume, then we will take a short position.  Our stop will be above 79.63, which is the current high of the pattern.  Our initial price target will be 73.06, which is 76.4% of the height of wave 1 as subtracted from wave 2.
• At 73.06, however, we will only exit 1/2 of our position.  Since there's a good possibility that this is still Wave 3, we'll want to ride this as far as we can.  Therefore, we will trail a stop for the remaining 1/2 ten cents above the previous day's high, adjusting that stop daily until we are stopped out of the position.
• At present, there is no long setup showing on the map that matches our trading horizon.  Now, that could change if we get a double bottom setup around 76.37, however that has yet to manifest.

Clearly, taking a short position in the extremely bullish market we've had for the past three weeks is increased risk.  Be sure to factor that into any decisions regarding position size and exit strategies.

Happy Trading.