The Curious Case of United Continental (UAL)

6 month TA on UAL

United, despite being an airline with notoriously bad service, and having a rough quarter (net loss in the first quarter widened to $213 million or $0.65 per share from $82 million or $0.49 per share in the prior year, below Wall Street consensus expectation), they recovered nicely in stock price thanks to smaller than expected loss in American Airline. In fact, they rise so much so quickly that they broke the bearish trend and coming right at the resistance level at around 23.5, as shown above.


Looking at fundamental, the huge loss in the first quarter made sense: rapidly rising fuel cost, dwelling economy leading to less passengers going on vacation or business travels, and the unexpected hit from the massive earthquake and subsequently tsunami plus radiation leak in North Japan. All these are big ticket hitter and should affect most international airlines. To add salt to the injury United is just going through merger with Continental and there will be some settling time with the integration, especially on how to cope with the unions.


So what's next? Fundamentally the travel season is beginning, and should help with their profit. Key part to watch is the oil price's movement which will have upside pressure from summer's fuel use (road trips, air conditioning, etc) and the unrest in the middle east. Downside pressure for oil includes European debt crisis and China's heavy hand on curbing inflation. The Japan case is still a mess, but rebuilding takes oil, too.


Technically if UAL breaks the second resistance at 24 then, though weak, they will be going in a bullish trend.


Disclosure: I had net short position on UAL, and no other airline exposure. And I hate United - they should go down and let someone better like Cathay to run it.

Market Fear

Have you ever wondered why the "velocity" of price drop usually far exceeds that of price gain? In other words, usually price drops much faster than price appreciation. I mean, aren't traders inherently greedy? Wouldn't they chase up what they seem to like, as much emotion as running in fear? To answer that question, we must probe at psychology of trades, in the field of behavioral finance.

There is a monumental paper titled Prospect Theory written by Daniel Kahneman and Amos Tversky from Princeton in 1979 describing human decision instead of optimal profit maximization utility theory. This paper has been quoted so much that it ranked second of all economic papers ever published. The first one was a statistical tools paper which presently have no additional value of what we have already known. So this Princeton paper can be regarded as the one of the most useful reference in finance and economics.

One of the key take-away from the paper is that people value loss much more than gain, despite equal magnitude in outcome. That is, the perceived loss in my mind for 10 bucks loss is far greater than perceived value of 10 bucks gain. And the reference point moves with one's wealth, so this greater perception of loss is present in most people regardless of the size of their wealth.

In addition, there is a tendency for people to overweight the small probability of loss, leading to a risk-averse attitude towards investment with small risk (probability of loss) and moderate reward.

Overweight of Small Probability of Loss

Notice that there is two discontinuities in the above graph, and that the perceived change of value is quite flat for a large range of probabilities in the middle. In other words, a winning chance of 40% is seemingly equivalent to 60% chance of profit in our mind, even though mathematically they are vastly different.

On the other hand people are also tend to overweight small probability of gain, leading to risk-seeking attitude towards investment with small probability of gain but moderate change of loss.

There is a third area in human psychology regarding risk and profit, and there exists several zones of comfort that is dependent on the size of one's portfolio or wealth, in which more risk is tolerable when the size of that bet is small regarding to the total size of one's wealth. This one is easy to understand, and I will not explain further.

Now let's come back to our original question. What happens when a trader see a group of sell orders showing up on exchange's quote feed? In his mind, a realization of things may go south occurs. Now we are in the region of "potential loss". Once the loss move past a trader's comfort zone (depending on the size of his trade, usually a small swing in prices will move past a day-trader's comfort zone because of the inherent large bet nature of day trading), panic will kick in very quickly. And the fear feeds on themselves as you may notice from the first graph above, that the drop of value falls rather quickly. This explains why price drop as a result of exodus sell would often be much deeper than any other euphoric rise of prices.