November 29th, 2012

Head-and-Shoulders Patterns: FDX Case Study

The key point in yesterday’s discussion of the GLD and AAPL head-and-shoulders patterns can be summed up in the post’s last paragraph:

“……. no matter how good these chart patterns may look a year from now, unless and until they cross their necklines, there’s no certainty today that they won’t fail to deliver.  While getting in early will produce a greater return, the trade entails significant risk that the stock actually winds up moving in the opposite direction.”

The point perhaps not made emphatically enough is that even though head-and-shoulders stock chart patterns appears on the surface to be similar to the results of a series of random coin tosses there is a major difference between the two should the price/value cross the neckline.  The result of coin tosses merrily continues on a random path, the path in the prices/values in stocks, indexes and commodities subsequent to a cross of the neckline usually becomes impacted by a feedback loop know as “momentum”.

When they see new highs or lows being set as the price/value crosses the neckline, investors expect, even anticipate, a continuation of the prevailing trend.  That predisposition causes them to place trades (either buy if a cross above or sell if a cross below the neckline) in anticipation of being able to close those positions some time in the future at a profit.  Coin tosses have no connection with the future but investors do.

The trading rule, therefore, is that investors should wait to commit to their prospective position until momentum is launched and the signal in the form of a neckline cross is evident.  [This presumes that a neckline is something obvious and concrete but that’s the topic for the next post.]

Let’s look at another example of that trading rule.  One advisory service recently substantiated their large position in FDX (Federal Express) by arguing that FDX was restructuring their operations so that their Express division is “refined” and their Ground operation “will lead to better margins and more market-share take against UPS.”  Somebody has to perform good fundamental analysis but it’s not clear whether individual investors are equipped or has the time to uncover and evaluate such information.  Large institutional investors (what I call “the heard”) do and what we can do is to follow their footprints in their hunt for big game.

If only a small percentage of the herd know or arrive at the same conclusion as the above the FDX analysis then price action in FDX shares will not be impacted dramatically.  If the analysis is correct and is reflected in operating results, the rest of the herd will join the chase and price momentum will begin.  If its efforts, the FDX shares will languish at best and fall at worst.  I would want to buy the shares only after, and not before, sufficient numbers of investors begin to believe in the FDX transformation and the shares begin to rise.

FDX stock has been restrained from continuing its uptrend by a resistance trendline (“neckline”) for over 5 years.  It isn’t relevant to the trading strategy whether you envision an emerging inverted head-and-shoulder pattern (square 1) or the longer-term ascending triangle (square 2).  To believe the story, you have to “show me the money”. You need to see the shares cross above the resistance trendline (the “neckline”) to have confidence that the uptrend momentum is sufficiently sustainable before foregoing other opportunities and putting your good money into FDX stock.  As my slogan says, “fundamental analysis is subjective, momentum is a fact.”

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August 2nd, 2009

Where Were You At Obama’s Election?

That’s not intended as a political question but rather interest in your portfolio’s health since then. The reason for framing the question this way is because Friday was a watershed day: the market closed at 987.40, nearly the identical level it was on November 4, 2008, Election Day, or 1005.75. It closed up 39.45, or 4.08%, from the 966.30 pre-Election close and has not been as high since.

After careening down since last labor day, through the Lehman bankruptcy and the Merrill Lynch acquisition, market psychology was temporarily bolstered over the succeeding weeks by announcements of the G-7 meeting and decision for a coordinated effort “to combat the crisis including the use of ‘all available tools’ to support key institutions and prevent their failure.” (If you are a masochist and want to relive those awful days, click here for an excellent timeline of all the gory details assembled by the St. Louis Fed.)

When you look at those two Index closing levels, you might think the last 9 months has been a boring, flat market. Au contraire, my friends. There’s been the equivalent of a bear market with a 32.73% decline to March 9 and a booming bull market with a 45.96% recovery since March in between. How did your portfolio perform over the same period. Having an average 40% in cash over the past nine months, my portfolio has gained only a disappointing 3.5% from last Election Day, net of dividends, commissions, interest, gains/losses and additions/withdrawals.

So for me, and perhaps some of you, the game is just beginning again. I can drool at all the profits that could have been made if only I had been less fearful and jumped back into stocks in a big way soon after the bottom (see March 19, “The Debate is Settled: The Market Has Hit Bottom“). I sought a safe haven, found it in cash but may have stayed there a bit longer that I should have.

As an aside, remember the Coppock Curve, Mean Reversion and MTI Indicators. I last checked in on them on May 1; two months later they look even more accurate at predicting the bottom. Coppock got it right again as the Curve has clearly trended up since May:

And the Mean Reversion Indicator? It’s still eerily similar to the path off the 1973 bottom (as a matter of fact, see the predictions of May 1 for a July close of 999.60 vs. an actual of 987.48). I wonder how long that parallelism will continue:

Finally, the MTI gave an “all-clear” signal on June 1 when the Index crossed the 200-day Moving Average. But that’s all history. Where do we go from here? I focused on all the money that’s parked on the sidelines needing to be invested as a possible catalyst for further market appreciation. “Z”, a loyal reader, recommended the following references as support to this notion: “Six Good Reasons to Like Stocks” from Barrons on August 3:

“There will certainly be a ton of buying power available once any bear conversion takes place. Cash holdings amounted to about 95% of the value of U.S. stocks at the end of the first quarter. Paulsen argues that given the current environment of inflation and interest rates, this ratio of cash to market cap should stand at around 50%. That would leave, by his reckoning, nearly $5 trillion of cash currently sitting on the sidelines available to push stocks markedly higher.”

and “Parked cash hoard: Fuel for further stock gains?” from Fidelity Investments on June 22 (the numbers are different but the conclusion is the same):

“Although investor cash levels have fallen from their record high in March, their value is still equivalent to about 40% of the entire U.S. stock market. This level of cash—as a percentage of what it could purchase of the overall stock market—remains much higher than the 27% peak rate seen during the 2000-2002 bear market, and well above the historical average rate of 16%….the cash stockpile on the sidelines remains so much larger than it historically has been that it would only take a smaller percentage of stock market re-entrants (relative to past cycles) to provide a significant boost to stock prices.”

So where should we look for stocks to lead the next leg up. Which stocks were involved in the Bull Market of Spring 2009 and which ones might take us through the end of the year?

More than half the stocks in the Telechart database, 56.3%, were higher this past Friday than they were on Election day. But what was most amazing is that the sectors up the most are those you wouldn’t necessarily expect, like retailers. As Bob Doll of BlackRock calls it a “relief rally” where investors said to themselves “Maybe this isn’t another Great Depression, and I’m underinvested in equities — I have to participate”; the speculated on the stocks that had been hit the hardest. Paul Lim, in today’s NYTimes, interviews analysts who rationalize that large caps with good fundamentals will support the next leg up.

I’ll go with the laggards since Obama’s Election: Banking, Real Estate, Transportation, Energy, Chemicals and Consumer Durables. That’s close to 1000 stocks of which many have formed beautiful reversal bottom patterns they’re about to break above. I’ll post a spreadsheet for you tomorrow.

June 25th, 2009

Transportation Stocks Might Soon Be Confirming Dow Theory

I haven’t written much about the Dow Theory because, quite honestly, while it’s a technical analysis sort of concept I don’t believe it to be stock charting the way I practice it.

Most consider the father of technical analysis to be Charles Dow, the founder of Dow Jones and Company publishers of the Wall Street Journal. In a series of papers around 1900, Dow described his belief that markets, as represented by the Dow Jones Industrial Average and the Dow Jones Transportation Index, tended to move in similar ways over time. Those papers, expanded by others in the years that followed, became known as “Dow Theory”.

The Dow Theory is usually broken down into the following six tenets:

  • First tenet: markets move in one of 3 trends – Up Trends, Down Trends and Corrections
  • Second tenet: trends have 3 phases -accumulation, public participation and excess phases
  • Third tenet: markets discount all news so that once a piece of news is released it is quickly reflected in price. [On this point Dow Theory is in line with the efficient market hypothesis.]
  • Fourth tenet: the Industrials and Rails Averages must confirm each other and if two averages moved in opposite directions it was a sign that the market was going to change direction.
  • Fifth Tenet: trends are also confirmed by volume.
  • Sixth tenet: trends exist until definitive signals prove that they have ended.

It’s point four, that Industrials and Rails must confirm each other, that I want to focus on because it’s the one most often mentioned by talking heads and the press. Also, there seem to be some interesting charts setting up in the various transportation Industry Groups that may point to a confirmation coming. IBD categorizes the many transportation stocks down into the following 7 Transportation Industry Groups:

  • Air Freight
  • Airlines
  • Transporation Equipment Manufacturing
  • Rail
  • Shipping
  • Transportation Services
  • Trucking

I previously wrote about the truck manufacturers, tires and replacement parts and heavy duty trucks because they all seemed to have begun performing extremely well (see “Truck Original Equip, Parts and Tires Under Green Light” from June 1). And now it appears that some of the above groups are also beginning to show some signs of life. Take, for example, the Rails, a group that’s still very low in ranking (150 out of 197), but one that’s begun climbing; its ranking has crossed above its 20-week moving average.

Two charts in that group that look interesting are:

  • UNP (Union Pacific)
  • CSX (CSX Corp)

Be prepared to hear a lot more over the summer about Dow Theory and the confirmation of the Industrials by the Transportation Index.

February 16th, 2009

Seeds of Next Bull Market? Shippers and Heavy Construction

It’s time for a reality check to see how the base building I described on January 26 is progressing. The negative news reported over the airwaves, in the press and in blogs continues unabated. You can take a pulse of the general consensus by reading the headlines presented in such aggregator sites as The Kirk Report and Abnormal Returns. Last time, the list was from The Kirk Report; this list comes from this past Friday’s Abnormal Returns (for links to actual stories, click the link above):

  • Earnings have collapsed. How long before they return to trend?
  • Absolute return mutual funds have been anything but.
  • The wave of bankruptcies is nowhere near cresting.
  • Germany is having problems placing its debt.
  • Is the US doomed to make the same mistakes that Japan made?
  • Europe, especially Ireland, is in bigger trouble than the US.
  • No matter how you measure the employment picture, it is bad.
  • Economist aren’t stupid. They are simply trying to explain something, the economy, that is too complex for us to understand.
  • Curing the common cold will be just about as easy as preventing future market bubbles.

I’ve heard it said in the news business that “good news doesn’t sell papers” nor does it hold on to TV viewers so it shouldn’t come as a surprise if the media hasn’t yet be able to shake their case of the blues. A couple of weeks ago I prescribed that you take a look at the market’s internal dynamics as a palliative for a sure case of investor depression. So how do those measures stack up now after two more weeks full of bad news?

Interestingly, and surprisingly, they continue to improve:

More than a third of stocks have successfully crossed above their 90-day moving averages as compared with only a fifth a month ago. Nearly one of every ten stocks are now above their 180-day moving averages as compared with one of every fourteen a month ago. It’s a greater challenge for stocks to cross the slower and more removed 300-day moving average; improvement there has only been marginal.

Finally, a large number of regional banks reversed their Golden Cross status (the index above the 90-day MA which was above the 180-day MA) because of serious erosion in the prices of the group, other stocks have risen to take their place holding the count constant though relatively small.

I’ve written here fairly consistently since the end of last year (see October 22, 2008) that I believe the market is working hard to build a base after the huge 2008 collapse. I’ve warned that patience is need since it would take some time until we get an all clear signal. But in addition to the Industry Groups I mentioned previously that appear to be leading in the base building effort (Oil, Fertilizer, Steel, Healthcare, Gold) here are two more offering some interesting basing action (click on symbol for charts; note time scales may differ):

  • Shippers
    • DSX (Diana Shipping)
    • TGP (Teeky LNG)
    • GNK (Genco Shipping)
    • VLCCF (Knightsbridge Tankers)
    • TBSI (TBS International)
    • NAT (Nordic American)
    • ONAV (Omega Navigation)
    • SSW (Seaspan)
    • PRGN (Paragon)
  • Heavy Construction and Engineering:
    • FLR (Fluor)
    • JEC (Jacobs Engineering)
    • KBR (KBR)
    • ACM (Aecom)
    • CBI (Chicago Bridge & Iron)
    • PCR (Perini)
    • STRL (Sterling)
    • ENG (Englobal)

Notice the similarities among these charts as all appear to be forming chart patterns: symmetical triangles, ascending trianges, wedges, cups-and-handles, downward sloping channels, head-and-shoulders – a true charting eduction. The similarity is understandable since the herd is stampeding these stocks for the same underlying economic reasons (yes, “fundamental” and “technical” analysis do sometimes overlap).

But a word of caution is warranted. “Looks can be deceiving.” We are in the early stages of what we hope is the beginning of the first phase (i.e., accumulation) in a new market life cycle. If true, then the charts will turn out to be true reversal patterns but, if not, then they will merely have been consolidation patterns followed by further downside.

Chart patterns often look compelling but caution dictates that you first merely put these stocks on your watch list and only later, after you see a breakout above the suggested trendlines by significant percentages and on above average volume, should you put one or two in your portfolio.

It’s too early to say how high momentum will carry these stocks if and when they do break to the upside. Each will face their own unique headwind and resistance. But “where there’s smoke there’s fire”. All these stocks can’t be basing without some fundamentals to push them in the same direction.

December 6th, 2008

Do You Believe It? The Airline Industry!

[Note: IBD mechanically ranks their 197 Industry Groups as follows: “A proprietary number obtained by calculating the least-squares curve fit of summed prices on certain stocks within that industry. Another calculation is then done using all companies in the group. Separate weightings are used for different time periods. Groups are ranked from 1 (best) to 197.”]

It’s been a long time since I last spoke about any particular industry group and with good reason. How could anyone single out one industry group as having prospects when nearly ever single stock was dropping like a stone.

This week, however, I had to dust off the Industry Group Tracker tool (my own take on how to best utilize IBD’s Industry Group Rankings) since Industry Group controls about 30% of a stocks performance (market being the prime mover at about 50%). Rather than just look at the Groups currently ranked at the top, I look for groups that may be ranked near the top in the future by highlighting Industry Groups that jump significantly in their ranking. And this week I saw something interesting.

My intent is to find stocks that, through their market action as recorded in their charts, appear to offer profit opportunities. I don’t explicitly factor in the reasons and causes for the price action; I piggyback on the fundamental analysis performed by the “herd” and watch as they charge a stock or group of stocks. Here’s what I saw this week:

Six of the Groups that moved up in rank continues to be the Regional Banks. I first wrote about Regional Banks (when the market was much higher than it is now) on May 21; follow up postings were May 24 and than again on October 11. Regional Banks are well represented in the list of “Golden Cross” stocks and the IBD 100 list.

But what really caught my eye was the Industry Group that moved up the most in ranking and the #1 Industry Group: Airlines. It was just Thursday that I lamented “Where Are Those Chart Patterns of Old?” And today, I find several stocks that look like they’re real honest to goodness reversal patterns. It’s understandable that this group may be bottoming and soon turning up because of the unbelievable decline in energy costs, the cut back in surplus capacity and the premium services they’ve introduced much to our dismay like extra charges for checked bags.

Again, I don’t pay much attention to “fundamentals” but here’s price action that’s compelling even if the fundamentals are almost unbelievable. All have “Golden Crosses”, three are “Perpetual Call Options” (stocks priced under $10) and many have favorable volume and OBV patterns. One, ALGT, is in the Model Portfolio (click on symbol for enlarged chart).

Have a good trip!

August 26th, 2008

Thank You, Readers; Shippers Interesting

I have a great group of loyal readers who take the time to comment and share their suggestions and opinions. Since the first of this month, they’ve suggested the following (in reverse order is you care to look at the comments): HNZ, ENS, WGOV, FMX, POT, AA, ACH, WMB, COF, SAM, SRS. I, too, have put my laid out some ideas for all to share but I think I’m losing to Anonymous when it comes to the number of recommendations.

What should come out loud and clear is that one must be cool and have the patience of a saint to be in the stock market. When you look at a stock chart it looks so compelling that you feel that you’ve got to jump on immediately. But three months go by, the market turns down and what looks like a sure thing now looks like some dead money for the foreseeable future until the market turns up again.

That’s why in market’s like these, until we get a signal confirming a bull market has arrived, the best strategy seems not to try to make a buck on a quick trade but to sit on the sidelines and let others fight it out for those few points. When we’re in a Bear Market, stocks that looked like they were about to breakout or bounce back only turn out to extend their consolidation or base building. A perfect example are the homebuilders and TOL. I first mentioned them on March 15 and TOL, specifically, on March 21. Today, they’re essentially were they were 5 months ago, still building a base.

Yesterday, Anonymous wrote:

“Whats your take, if you have one, on steel and nat gas, they seem for example like PKX [click here for chart] which is down at its March lows worth a trade with a tight stop like the SLV was a week or so ago. And on the nat gas side the UNG [no comment on “falling knives”] seemed like kind of a no brainer yesterday and it was as it spiked today. Any take or are you just staying away from the falling knives?”

My answer is by asking another question: Is there greater profit with less risk buying a breakout or buying a successful bounce off a trendline retest? I first wrote about this question on December 18, 2005 and still haven’t made up my mind.

Having said that, some beautiful long-term charts forming for the shipping stocks. I don’t know how long it will take until they’re resolved either as a breakup or down but it will interesting to watch:

  • EXM (Excel Maritime)

  • DRYS (Dryships)
  • DSX (Diana Shipping)
  • May 19th, 2008

    Trucking Industry Group: CNW, FFEX, FWRD, KNX, MRTN, ODFL, WERN

    In a response to a reader’s question about the Transportation-Trucking Industry Group, I repeated one of my favorite stock market quotations:

    “50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own.”

    I searched looking for its origin and finally tracked it down to Prof. Benjamin F. King of the University of Chicago back in the 1960’s, just about the time that the Efficient Market Theorem was being published (you’ll have to read my book when it comes out at the end of the summer to learn more).

    There couldn’t be a better current example of this quotation at work today than the stocks in the Trucking Industry Group. Seeing all these charts side by side sends my heart racing. Many of their charts look like they were cut with a cookie cutter; if they were on printed on transparent paper they’d overlay almost perfectly. And I’m not talking here about a week, a month or a year; this is a multi-year picture. With the limitations of a blog, you’ll just have to pop these charts by clicking on the symbols and look at them side by side:

    There are two exceptions to these patterns: a couple of stocks that have bucked the trend and had continued to move up, ever so slightly, and those that fell precipitously and have a long way to climb back. Coincidentally, I was asked for my opinion about YRCW on April 20 (perhaps the same reader asked again, more generally, about Truckers). I answered then:

    “I wouldn’t touch YRCW with a 10-ft. pole. It is the proverbial falling knife. There may be a chance you could pick up a bounce but then again, it may sink further. Why take that chance.

    If it does start moving up it has to fight the headwind of all those people who bought at higher prices all the way down and see an opportunity to finally get out with a smaller loss than they expected. saw may better opportunities.”

    If that reader had ignored my response, they would have enjoyed seeing YRCW rise from 14.70 on the previous close to 19.53 as of 11:00 today. But I would still buy one of the above stocks before YRCW because of the lower degree of risk I see in their charts.

    Bottom line? One of these days, the talking heads on CNBC will be touting truckers because the economy will be in recovery and thriving again, because the weight of gas and diesel will be lessened. They’ll want you to believe that this is their discovery, their expertise, their special knowledge (or else why would they be making the big bucks). But, in truth, it’s something that anyone could have discovered by looking at the charts.

    The challenge is not finding what to buy – that’s the easy part. The tough part is: 1) knowing when to buy something and 2) knowing what not to buy (or if you made a mistake, cutting your losses quickly). So wait until you see a trigger event, until the stocks break through those upper boundaries. Let the first few percentages go for insurance sake.