Stormy Weather for SolarWinds?

 | Dec 22, 2011 | 1:00 PM EST  | Comments
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Stock quotes in this article:

swi

,

spy

,

orcl

,

vmw

This commentary originally appeared Dec. 22 at 11 a.m. EST on Real Money Pro – Click here to learn about this dynamic market information service for active traders.

Shares of SolarWinds (SWI) have put on a stellar performance in 2011, and in the process the software company has become something of a Wall Street darling. While the overall market has sputtered all year, shares of SWI have risen more than 47% year-to-date. The majority of those gains have occurred since Sept. 22, meaning SWI has been as hot as the sun for the past three months.

While this performance may conjure images of investors happily lazing on a sunny beach, there may be clouds gathering on the horizon. Lately, SWI has cooled considerably; after reaching its year-to-date intraday and closing high on Dec. 9, the stock has been behaving erratically and may be setting up for a fall. Since that day less than two weeks ago, SWI has fallen 12.86%, while the SPY has only lost 1.5%. But while SWI (gray) has outperformed the SPDR S&P 500 (SPY) (yellow) overall this year, recently an ominous shape has appeared that is visible even on a line chart -- a bearish head and shoulders pattern.

SWI vs. SPY -- Daily
Source: TradeStation

What is troubling SolarWinds? Industry leader Oracle (ORCL) took a beating yesterday, falling 11.66% on 6x average volume. Also yesterday, competitor VMware (VMW) lost nearly 10% of its value on 5x average volume. But even if we can chalk up yesterday's 5% loss in SWI to a sympathetic dive with other software makers, this doesn't explain away a series of technical negatives that have cropped up on the stock's chart.

The stock has been getting hit hard on high volume recently; the two highest volume days so far in December were not pretty, with the stock losing 5% of its value on Dec. 14 and another 5% yesterday (shaded in yellow). On both days, SWI exceeded its average volume by more than 50%. Yesterday was also the first day since Oct. 7 that SWI traded beneath its 50-day moving average on an intraday basis (blue).

Yet another troublesome sign is the erratic nature of SWI's recent pullback. The arrows on the bottom of the chart point to the stock's average true range (ATR), a measure of a trading instrument's volatility. SolarWinds' ATR has been rising steadily, and has increased by 50% since Nov. 17.

And of course, there's that gloomy head-and-shoulders pattern mentioned earlier, which is also clearly visible in the stock's candlestick chart.

SWI -- Daily
Source: TradeStation

So let's review. After a spectacular year of outperformance, peaking on Dec. 9, the following has occurred to SWI:

  • head-and-shoulders pattern
  • increasing volatility
  • high-volume selloffs
  • testing support on 50-day moving average
  • underperformed the overall market
  • five-week intraday and closing low yesterday
  • bad news in from Oracle, leader of its sector

That's certainly enough to prevent me from buying this dip in SolarWinds, in fact it's nearly enough to get me to short it.

One thing SWI has going for it is that despite its troubles, Oracle managed to stay above a key support level yesterday, its year-to-date low of $24.72. As long as ORCL stays above that key low, formed back in August, this should help create support for SWI. But if that level breaks, and/or if SWI trades heavily beneath its 50-day MA, watch out. Either of these events could act as a trigger for a short entry in SWI.

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