We’re fast approaching the end of the year. Yet there’s still a lot to play out.
One major item will be the Federal Reserve’s last meeting for the year (which kicks off today). Tomorrow, we’ll find out its latest interest rate decision…
Plus we’ll get a look at the Fed’s economic projections for the new year.
The market will scour Chair Jay Powell’s post-meeting interview to learn the Fed’s plans for interest rates in 2025.
Against this busy backdrop, it’s easy to forget that companies are announcing Q4 earnings.
But it’s worth paying attention… especially to stocks tied to the AI boom we’ve seen this year.
Today, I want to look at one clear leader that has benefited enormously from introducing AI into its products. It recently tanked despite beating forecasts.
So let’s check out where it is heading next…
AI Is Not Enough
After reporting Q4 earnings, digital content giant Adobe (ADBE) gapped lower. It lost almost 16% in two days.
Worse still, ADBE is now around 26% lower than its early February high.
That sharp fall came despite ADBE easily beating revenue and earnings forecasts. And its Document Cloud growth was up 17% year over year.
But it lowered its growth estimates for next year. That was the reason behind the drop… despite ADBE being a market leader and beneficiary of AI.
Companies priced for perfection are vulnerable to a correction if growth slows down.
Put simply, having an AI narrative is no longer enough to push a stock higher.
That’s something the market will have to deal with more in 2025. Many investors are overexposed to AI-themed stocks.
You can see ADBE’s fall in the chart below…
Adobe (ADBE)
Source: e-Signal
When a stock falls like this, greed can take over and encourage you to try to pick a bottom.
But “catching falling knives” is almost a surefire way to lose money…
Instead, we need to be patient and wait for the right setup.
Stocks typically become overstretched in these types of big moves. The aim is to profit when they snap back the other way.
And one of my favorite tools for this strategy is options.
So what am I looking for next?
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Catch the Turnaround
As the chart shows (orange circle), the Relative Strength Index (RSI) is tracking close to oversold territory (lower gray dashed line).
But that’s not enough in itself to warrant a long trade.
Instead, we need to wait for the RSI to form a ‘V’ and rally. (You can see examples of this with the gray arrows on the chart.) That will help us catch rising momentum pushing ADBE higher.
Take another look:
Adobe (ADBE)
Source: e-Signal
Because we use options, we don’t need a major reversal (although we’re happy to ride one)…
The goal for a mean reversion trade is simply to catch the turnaround. And we bank our profits when we see them.
The quicker we can put our capital to use again, the higher returns we can generate over time.
Also, remember that volatility increases when you see a big move like this. That makes options more expensive.
So we want to let volatility subside a bit while the stock price finds a base. Then we can buy a call option to take advantage of a potential rebound.
I’ll be watching ADBE for a potential bounce from now into the new year. You might also want to put it on your watchlist too…
Regards,
Larry Benedict
Editor, Trading With Larry Benedict