January 24th, 2013

AAPL Update

imageA friend asked last night whether it might be time to jump on AAPL, now that it’s dropped so precipitously.  I referred him back to a piece I’d written early last November when the stock was at 563 entitled “AAPL Gets a Cold, the Market Gets …..?” in which I said that AAPL was forming a perfect head-and-shoulders top reversal pattern and, if it held to completion then the stock could fall to 385.

At the time, a call that AAPL would fall to 385 looked bold.  However, head-and-shoulder patterns are one of the most reliable chart patterns as are the mirror image of inverted head-and-shoulders as bottom reversal patterns (click on image to enlarge).

AAPL - 20130124

AAPL gapped down 61 points, or 12%.  My friend asked three questions: Why didn’t you sell short when you had confidence in the chart?  Should I sell short now?  Or should I buy now since it’s dropped so much already?  Typical questions that we ask every day about every stock currently in our Model Portfolio or stocks that we are looking to buy.

The first two question can be answered as a matter of general policy: I don’t short stocks.  I’ve tried it over the years and have lost money nearly each time.  Stocks can double if you hold them long enough in good market conditions but the odds of them falling 50% is rare.  We believe that the market controls 50% of a stocks action, industry 30% and factors specific to the individual stock only 20%.  Furthermore, based on my study of the stock market over the past 50 years, I know that the market increases 70% of the time.  So the odds are against you 70% of the time when you bet a stock will decline by selling it short.  You have to have close to 100% certainty that a stock will decline before taking on such long odds and, because I trade stocks based on my assessment of supply and demand dynamics rather than fundamentals, I never have that level of certainty.

The answer as to whether AAPL is a buy today is also rather easy and summed up in the Wall Street saying: “Never try to catch a falling knife”.  Right now, AAPL is clearly a falling knife.  Someday, somewhere, it will hit the ground; it’s just that we don’t know where.  When it does, the tide of momentum will have to reverse.  AAPL fell because almost every large institutional investor had AAPL as one of their major holdings.  There just wasn’t anyone in the market to sustain the demand and keep the price rising.  The balance of power flipped from demand-driven momentum to momentum propelled by supply.

As the chart above indicates, it took eight or nine months for momentum to turn from demand to supply; it will take an extended period of time for it to flip back from supply to demand.  Individual investors don’t have to be the first ones to climb on that train since we have no way of knowing when it will change direction.  What we do know is that there will be plenty of time for the individual investor to climb onto a moving train that has as large capitalization as AAPL.

My earlier guess was that the “roundhouse” will be in the 350-400 range.  No need to panic and buy now.

December 6th, 2012

More Reliable: Horizontal vs. Sloped Trendlines?

Over the past several years, charts have become more pervasive than ever in discussions, commentaries and prognostications about individual stocks and the market in general.  Even Cramer, who once considered technicians to be on the same level as astrologers or readers of tea leaves, no regularly refers to the analysis of one chartist or another.

One of my pet peeves, however, is that bloggers and media talking heads will insert trendlines in their discussions almost willy-nilly as they pontificate about the support or resistance they hope the line they drew will presumably offered them. Because the use of trendlines is so prevalent, it’s assumed that everyone understands their meaning and relevance; we rarely hear about the arbitrariness and subjectivity that goes into their selection.

Last week, I offered three examples of head-and-shoulders patterns (GLD, AAPL and FDX), each demarcated by a horizontal trendline, or the pattern’s “neckline”.  [As an interesting aside, I may have been one of the first to publish an alert about the possibility of AAPL forming a head-and-shoulder top which could result in a correction down to approximately 400 in my November 8 post, "AAPL Gets a Cold, the Market Gets …..?"  Now many are commenting about it and Cramer even had a segment tonight dismissing the stocks technical risks.] What makes the head-and-shoulder such a “reliable” (if you allow me to use that term in the context of something so subjective as the reading of stock charts) pattern is that the supporting trendline is horizontal.  I’ve seen sloping necklines but these never turn out to be as recognizable nor as accurate.

As I describe in my book, Run with the Herd,

What makes trendlines so confusing is that many trendlines that seemed so precise at first may lose their potency as new trading is tacked on.  As a matter of fact, as more transaction data over longer and longer periods of time with multiple trading days condensed into individual bars, you’ll usually find yourself drawing a plethora of trendlines.  Some trendlines are short and some long, some connect pivot points that once seemed compelling and inviolate become less significant and even irrelevant when viewed in a longer-term.  The support or resistance expectations implicit in short trendlines at one may become overwhelmed and irrelevant as more recent buying and selling emerges.

Trendlines are nothing more than an arbitrary, imaginary lines that visually connect two or more pivot points. Pivot points are those spaces in time and price where control is transfers between buyers and sellers, when one trend in one direction reverses and begins moving in the opposite direction. In reality, this transfer doesn’t occur in one transaction at one price but instead occur over a period of time, a large number of trades at a range of prices.  There’s no precise way of locating when that transfer is complete and the struggle continue even when a reversal appears to be complete.

Why is it important to locate these pivots? Because we believe that after having occurred several times at approximately the same point, the failure to occur at that same level sometime in the future means that the winner of the last battle has lost control of the trend and it now resides in the other side who will control the trend until the next struggle begins.  That transfer of control is the breakout.

Repetitive struggles at the same price make intuitive sense.  An institutional investor looking to sell its large holding in a stock will continue to do so as long as a stock’s price is above a certain level; when it drops to or below the level they hold their shares back from the market; they will continue to accumulate shares up to a certain price but not above that price.  But what can we say the same thing about pivot points at different levels?  Bottom line, they tell us little about what we can expect about where the next pivot might be and we can say little about whether that recent pivot is the beginning of a reversal or the continuation of a trend.

The above chart for LKQ presents a pretty channel but it offers little information about the risks of the trend failing, how much profit potential remains in the channel trend or when it might collapse.  It is easy to draw the channel trendlines after the fact but drawing those lines in 2010 would have produced the dotted trendlines.  Which more accurately defines the trend, the solid or dotted lines.  Is the stock currently within the trend boundary or is it outside the bounds and bound to correct.  The most common mistake when inserting trendlines is thinking that the recent pivot is critical in establishing a meaningful trendline.  In other words, trendlines are usually discovered within the time frames of the chart, rarely coming in from prior the chart’s beginning.  That’s why I always simultaneously look at a charts in three time horizons.

That error doesn’t occur when you look for breakouts across horizontal trendlines like this one for NEOG.  Is there any doubt that a cross above 48.00 indicates that the bears have lost control to the bulls who have launched a new push to higher stock prices?

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November 28th, 2012

Head-and-Shoulders Patterns: AAPL and GLD Case Studies

In my book, Run with the Herd, I retell the coin toss experiment from Burton Malkiel’s book, A Random Walk Down Wall Street.  In it, he asked students to

“continuously toss coins with heads arbitrarily representing a move up in a stock’s price and, conversely, tails a move down.  All the price changes were assumed to be of equal magnitude and all were recorded in a line chart.  After an unspecified number of tosses, the students began to see patterns in the charts that looked similar to those of stock charts.”

One of the most talked about, recognized and perhaps most reliable stock chart patterns are the head-and-shoulders and its mirror image the inverted head-and-shoulders. What makes these patterns so important is that they fall into the reversal category (as contrasted with the continuation or trending patterns).  In these patterns, the price/value of the stock, index or commodity makes three different attempts to reverse the direction of the prevailing trend.  Characteristically, the price/value reaches approximately the same level the first two times and then falters; it succeeds in the third attempt and crosses the level reached the previous two attempts. The elements of the pattern include a shorter left “shoulder”, a longer middle “head”, and a shorter right shoulder; all are connected by a trendline at what is called a “neckline”.

As you might expect, as a chartist I believe that comparison between the randomness of coin tosses and stock chart patterns is a false one using the wrong logical argument (incorrectly using deductive reasoning rather than inductive reasoning).  But it is true, however, that the head-and-shoulder chart patterns are easier to perceive in retrospect and not as readily discernable in real-time.  Furthermore, when the pattern has evolved sufficiently in order to actually intimate its future likely outline, the practical question remains as to when might be the best (highest probability of being realized with the lowest risk of being failing) time to act on that perception.  Here are two cases in point:

    • AAPL: At the beginning of the month, I wrote a piece entitled “AAPL Gets a Cold, the Market Gets …..?” when the stock was at 563 in which I included a chart showing a partially formed head-and-shoulder pattern and wrote: “Has the stock hit bottom and is it poised for a turn around (a large Wall Street firm recently called on CNBC for AAPL to more than double over the next year)?  Double it might but in the near-term it’s setting up for another 25% decline below what might be consider the neckline of an emerging head-and-shoulder topall the way down to 390 (nearly 30% from current levels).”Compare the chart in that post with the one below and you’ll find that AAPL is closely following the course outlined there:

      Although Robert Weinstein of Cramer’s theStreet.com wrote today that investors should “Put Away the Prozac, Apple’s Just Fine”, this emerging pattern continues to look to me uncannily like an emerging head-and-shoulders top [Cramer's Action Alerts Plus service has been a long-term AAPL investor with a 90+% profit].  There’s no way to tell whether the stock will follow-through but it pivots and starts declining again, I would order a refill from the pharmacy.

    • GLD: I wrote a piece at the beginning of the summer entitled “When It Comes to Technical Analysis, Accuracy Depends on Time Horizon (GLD)” in which I included a chart of GLD with a pattern that looked like a descending channel and wrote: “I look at a possible breakout from my flag and see a long-term move equal to the preceding the neckline.  I see the possibility of a 75-80% move to the 250-270 level over a year or two.  It all depends on how much time you want to spend managing your portfolio and making trading decisions.”

Today that channel has morphed into what might turn out ultimately to be an inverted head-and-shoulder pattern.  The hesitation in calling it that is that the pattern is developing after a major bull run rather than at the bottom of a major decline.  Consequently, this inverted head-and-shoulder will further morph a consolidation pattern or some type of reversal top pattern.

Bottom line, no matter how good these chart patterns may look a year from now, unless and until they cross their necklines, there’s no certainty that they won’t fail to deliver.  While getting in early will produce a greater return, the trade entails more risk that the stock moves in the opposite direction.  [In fact, even after a trendline is crossed, the stock will often reverse and test the trendline in what is called a "Buyers'/Sellers' Remorse Correction".]

 

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November 8th, 2012

AAPL Gets a Cold, the Market Gets …..?

I searched this blog to see what I may have written about AAPL over the years and found that there have been 15 individual posts since 2006, many comparing AAPL and GOOG (search other terms by using the search button in the lower left panel).

But situation is dramatically different today than it’s been at any previous time [haven't people gotten into a lot of trouble when they claim "this time it's different"?]:

  • Jobs is no longer the creative or leadership head of the company,
  • the company now has competition for its products (e.g., Samsung) and its services (iTunes vs. Pandora, Spotify and Amazon)
  •  the stock became the largest capitalized stock in the world and held a dominant role in all market indexes
  • the stock is considered “overbought” being a large position in nearly every mutual, pension and hedge fund,
  • finally, some blowback is now being heard and felt about the product introduction rate and design [note: the discontent with the connection format change and the mapping service disappointment].

So, I’d like to toss my stock chartist’s view of the “bear market” that has captured the AAPL driving it down 18% over the past two months.  Has the stock hit bottom and is it poised for a turn around (a large Wall Street firm recently called on CNBC for AAPL to more than double over the next year)?  Double it might but in the near-term it’s setting up for another 25% decline below what might be consider the neckline of an emerging head-and-shoulder top all the way down to 390 (nearly 30% from current levels).

Supporting this negative view is the long-term negative divergence existing between the trends between the two price peaks in 2012 and the comparable peaks in the OBV volume trend.  OBV indicates the relative volume between buyers (closes higher) and sellers (closes down).  In other words, as AAPL churned higher it was on less volume than those days when it closed lower.

Unfortunately, AAPL represents a large component of the major indexes so “when AAPL sneezes, the market gets a cold”.  Let’s hope that cold doesn’t turn into pneumonia.

August 10th, 2012

GOOG to 1626?

There couldn’t ever have been a more interesting and exciting IPO than the GOOG (Google).  I last focused in on GOOG back on June 12, 2007 when I wrote:

As a precursor of its novel approaches to problems, whether technical or business, August 19, 2005 was GOOG’s on NASDAQ through a little-known Dutch auction process with the stated intention of attracting a broader range of investors than the usual IPO. Almost immediately, the stock started marching to new high territory…..The Google lesson is that the best strategy (and the one taking the most discipline and guts) is to stick with this sort of stock where, regardless of external market factors (note the S&P corrections in Aug-Oct 2005, May-August 2006 and Feb-Mar 2007) is early enough in its product and business life cycle that it only suffers relatively minor retreats.”

GOOG was 511 on that date and it traded five months later at 741.  But that was the end.  Since 2007, the stock has been stuck in a multi-year trading range of approximately 433-633 (excluding its major correction during the Financial Crisis Crash of 2008 when it fell briefly to 250):

The question today is whether GOOG will join other mega-cap tech stocks and break across long-term resistances like IBM, AMZN(click on symbol for chart)?  There are only two possibilities: the horizontal channel morph into a double-top carrying the stock back to its IPO price of nearly 10 years ago (or at a minimum to near the 2008 lows) or it will cross the resistance and launch a new multi-year bull move.

I’m guessing that it’s the latter.  With all the sidelines money that is going to need to find a relatively low risk home there aren’t many stocks along the lines of GOOG with a sufficiently large enough capitalization that can absorb the money flow.  As a matter of fact, if AAPL falters on the introduction of its iPhone 5, fails to introduce a new T.V. or has some other disappointments in its product rollouts then some of the money that has been riding the AAPL gravy train when Jobs was running the company may look to GOOG to again be the tech standard bearer.

AAPL has significantly outperformed GOOG over the past 10 years but it may be GOOG’s turn to play catchup.  If the market does successfully approach and then cross into all-time new high territory then I wouldn’t be surprised to find GOOG more than doubling to 1626 over the next couple of years..