Category Archives: Patterns

February 16th, 2012

Parallel trendlines for positioning targets

There are those who follow Bob Prechter, one of the strong proponents of the Elliott Wave principles have their ways of identifying price level targets.  And then there’s the crowd who hide out at Slope of Hope, the place where perma-bears can always find a reason for an impending correction or “much welcomed” bear market crash through targets derived by their overly precise application of arcane Fibonacci mathematics.  But I’ve always found a rather simple approach to projecting out potential targets by applying a resistance trendline parallel to the corresponding supporting trendline and thereby creating a channel.

Take for example XHB, the homebuilders ETF.First, you should note how reversal and consolidation patterns easily morph from one form to another without a general market tailwind.  Until last summer’s meltdown due to the domestic budget and European sovereign debt crises, it looked as if XHB would break out the upside of a symmetrical triangle.  Since last summer’s 30% decline, it now appears that pattern has morphed into an ascending triangle and, with cooperation of a more constructive general market backdrop and expectations for finally an improved housing market, that upside breakout might now be at hand.

If break out does materialize, the next question is what might be a reasonable target for the move higher?  Consider a parallel line as on benchmark:

Parallel lines are simplistic and anything but elegant but they usually work.  They definite position a target for one’s expectations.  They won’t let your dreams run wildly out of control and add a time dimension to a price expectations.

Reality never really works so perfectly but, if the market and XHB dramatically diverges from this trajectory then we can make mid-course adjustments when and to the degree necessary.

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January 25th, 2012

“The Great Convergence”

In last week’s Recap Report recently sent to subscribers, I wrote and included the following chart:

“….. at the risk of being labelled melodramatic …. I see “The Great Convergence” coming to a head and finally getting resolved with the 18-month struggle between bulls and bears with (I hope it’s not just wishful thinking but an actuality) the bulls finally gaining the upper hand and finally being able to break into new higher ground.”

After today’s close and after closing higher for 20 of the last 23 trading days, the market is now up 10.01% since December 19.  Even more important is to note that today’s close was at 1326.06, almost exactly the level many chartists have touted as the breakout point that confirms an exit from this summer’s bear market and the continuation of last year’s bull market run off the lows.

It should also be noted that it’s almost exactly where the descending trendline connecting the 2007 and 2011 peaks is today.  However, rather than thinking in terms of points (e.g., 1325 or 1326) we need to think of a zone.  Every single trader doesn’t simultaneously decide to buy or sell which in turn causes a reversal at a single point.  Furthermore, the Index is composed of 500 different stocks in every economic sector and each of these stocks will have their own underlying market dynamics.  Market psychology does change when the market hits various levels but a change of psychology happens over time.

What the above chart indicates is a change in market psychology that’s been on-going since the bottom of the Financial Crisis Crash (see “Revisiting Housing and Banking With a New Ending” of a few days ago).  The ascending trendline since the bottom (higher lows) and the descending trendline from the pre-crash peak (lower highs) results in this “Great Convergence”.  The best momentum indicator (in my book) of moving averages across multiple time horizons are turning constructive adding to the conviction that a clear-cut signal to put, as they say in Wall Street, “risk back on”.

I believe there needs to be a 4-6% consolidation of this 10%, 23-day run and we’re going to look at it as a buying opportunity.  But if the market continues to zoom ahead another 2-3% without that correction, then it’s “damn the torpedoes, full speed ahead.”

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January 24th, 2012

The Outlook for FXI and Chinese Stocks

From the EconomicTimes of India:

“China’s economy is showing signs of slowing, with foreign investment falling for the second straight month in December and home prices dropping in most cities, the government said Wednesday.

The latest indicators came a day after data showed the economy expanded 9.2 per cent last year, narrowing from 10.4 per cent in 2010, as global turbulence and efforts to tame high inflation put the brakes on growth.”

From USAToday:

“China’s gross domestic product grew at its slowest pace in more than two years in the fourth quarter, and the worst may be yet to come, as weak exports and government tightening ripple through the world’s second-largest economy.

In the final three months of 2011, China’s GDP — the total value of goods and services — increased 8.9% from a year earlier. That was a fourth-consecutive quarter of slowing growth and the slowest expansion since the second quarter of 2009, when the economy grew 8.2%, the Chinese government said Tuesday.

For all of 2011, China’s economy expanded 9.2%, compared with 10.4% the year before.”

And finally, from The Guardian in the U.K.

“China’s economy is also “unstable, unco-ordinated and ultimately unsustainable”, a verdict delivered not by some capitalist running dog on a Canary Wharf trading floor, but by none other than premier Wen Jiabao. Nevertheless, any appraisal of China’s prospects must begin by admitting that the Middle Kingdom is the most astonishing development success story in the world today, and that its three decades of 9%-plus growth have been achieved in the face of widespread scepticism from foreign observers.”<

When we look at a chart of FXI, the ETF of Chinese stocks, we see a classic inverted head-and-shoulder or ascending triangle or any of a number of bottom reversals:

From the above chart it appears that the Chinese market would rebound in sync with the US market ….  should that come to pass.  The extent of that rebound, however, is bound by different constraints than the US market when viewed from a longer-term term perspective:

This short-term inverted head-and-shoulder may signal the beginning of a Chinese market recovery but a complete reversal of its long-term downtrend would also require a cross above a long-term descending trendline stretching back to the heydays of 2007 followed by a cross above the top boundary of what now looks potentially like a multi-year ascending triangle at 46-47.

The near-term inverted head-and-shoulders supports a move to 47 but moves above that need more umph and momentum to overcome their local economic and international trade challenges.

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January 6th, 2012

Is the Secular Bear Market Close to Ending?

A recurring theme among some reporters and bloggers is the possible breakout of the mega-caps.  I believe one cause for this line of reasoning is the persistent dream of an end to what is now the 12th year of the secular bear market.  A name that continues to come up as emblematic of this breakout thesis is WMT (Walmart).  Any stock chart aficionado salivates over the potential of a stock like WMT.  When stuck in a horizontal trading range for over 10 years there’s the potential of a huge move should a breakout above that huge wall of resistance is ever successful:

But WMT isn’t the only large-cap stuck in the secular bear market trap.  As a matter of fact, half of the 30 Dow Industrial stocks are below where they were on December 30, 1999 (WMT is down 12.8%). There are a number of large-cap stocks not part of the DOW that also have charts that have attractive potential should they break above their own multi-year resistance levels:

  • MSFT (Microsoft)
  • AMGN (Amgen)
  • QCOM (Qualcomm)
  • DIS (Disney)

What we’re all waiting for are stocks to breakout like IBM because when more do, we’ll be certain that the 12-year secular bear market will have ended:

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December 28th, 2011

Big Pharma: Industry Group with Upside Potential

While market direction and momentum trumps everything else, the Industry Group in which a stock belongs ranks second in importance.  A subscriber to Instant Alerts last week brought to my attention a stock that, on further research is in an Industry Group that is worthy of taking a nibble into if the market will be able to sustain some sort of upward bias as we enter the New Year.

“Big Pharma” stocks, or the larger stocks in the Ethical Drug Industry Group, all seem to be forming nice size, well formed (so far) bases which could, with a good tailwind, be among the leaders in next year’s market.  The Group has consistently ranked among highest among IBD’s 197 Industry Groups: Among the largest firms in the group whose charts show the early makings of nice bottom reversal patterns (a few have already broken above the top boundaries) include (click on images to enlarge):

  • BMY (Bristol Myers): crossed above a nearly 10-year long resistance trendline
  • LLY (Eli Lilly): crossed above upper boundary of an ascending triangle but is now facing a nearly 10-year descending resistance trendline which it failed to cross over in 2007 and may fail again next year.
  • GSK (GlaxoSmithKline): Let’s not split hairs. Was it an ascending or symmetrical triangle or was it an ascending wedge? It doesn’t really matter that much since stock is clearly trudging higher.
  • PFE (Pfizer): Same as GSK, ascending triangle or wedge? Same as LLY, facing a long descending resistance trendline.
  • NVS (Novartis): An nice inverted head-and-shoulders which, since it’s not at the bottom of a trend but at the top might be called, in IBD parlance, a cup-and-handle.

Others with patterns that are not as fully developed and still in progress include:

  • SNY (Sanofi-Aventis): an ascending triangle
  • AZN (AstraZenica): a 10-year horizontal trendline that needs to be crossed.

A lot to digest but, with a more cooperative market, some potentially good fruit to pick from.  Note: all of these stocks pay dividend with yields currently 3.6% up to 4.8% for GSK.  They are about the only stocks among the 45+ in the group that do pay dividends.

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December 1st, 2011

Avoid the Siren Calls of Sloping Trendlines of Hope

It’s time for a little “chartology”, a primer in chart reading.  Of course these opinions are personal but they are based on many years of hands on experience making successful use of and, sometimes, being disappointed by charts.

At the beginning of November, in a piece entitled “Sloping or Horizontal Trendline: Which Is More Reliable“, I wrote:

“if I have to chose between an ascending (or descending) trendline and a horizontal one to drive my decisions I would look to the horizontal one. I can’t easily calculate where the trendline will be a month or two out. But I can easily see whether there are any horizontal trendlines that mark where buyers and sellers have traded places for control of a stock’s trend. Those are the transfers of power that I rely on to help me anticipate what might be ahead for a stock (or Index).”

Another perfect example presented itself today when a fellow blogger Springheel Jack wrote a piece on the Slope of Hope about the prospects of a break out in the much maligned and downtrodden financial sector (primarily, banks).  According to a chart presented by Jack, there is a descending trendline from the pre-Financial Crisis top in May 2007 to the failed attempt to move higher this past spring.  In addition to descending trendline, chart also shows Price/Volume bars with struggle for power between the 14-16. Resolution of that struggle will signal either beginning of trend reversal or consolidation for further move down.  The chart with his annotations was:

Descending trendline

From Springheel Jack at Slop of Hope

My chart of XLF and its resistance trendlines looks like this:

Note:

  1. Any number of sloping trendlines could have been draw over the past two years which failed to generate a trend reversal.
  2. There are several horizontal trendlines at key price levels that have over the past several years acted as pivot points the barred further recovery in XLF.  Currently, that level is 13.50 followed by another hurdle at 15.50 and, finally, a breakthrough that would mark a true momentum trend reversal at 16.60.
  3. Rarely are ascending supporting trendlines mentioned but there is one stretching from the March 2009 bottom to the low last Friday.  That ascending trendline carries about as much significance as Springheel Jack’s descending one but, if you need an exit point that marks failure it would be the stock violating that ascending trendline.

Bottom line, don’t be swayed by the siren calls of commentators singing the song of descending sloping trendlines.  Look for the horizontal walls of resistance which if scaled truly marks an escape from a trading range trap.

November 18th, 2011

What Happened to the Symmetrical Triangle

Magnifying Glass Markets like such as we’ve been suffering through since June tests the loyalty and dedication of most believers in charting as a trading tool. Nothing that’s happen in the market since the European crisis fully bloomed at summer’s beginning has been actionable for trend followers with any degree of confidence or certainty.

Chart patterns actually represent the convergence in time and space (i.e., prices for stocks and levels for indexes) of a condition of balance between supply and demand that is bounded by one sort of trend line or another (ascending, horizontal or declining). If chart patterns depict equilibrium conditions then it’s futile to use them to predict the direction in which that equilibrium will be broken. We can state with some degree of confidence, however, that over the long run patterns will tend to break to the upside between 60-70% of the time because that’s the percentage of time that markets are in bull mode.

Take the symmetrical triangle we’ve watched forming over the past several weeks and finally broke down dramatically yesterday. As fellow blogger Springheel Jack on Tim Knight’s typically bearish blog Slope of Hope points out, “these triangles are poor performers on downwards breakouts, with only a 48% chance of reaching the target in a break down.” He goes on to quote the “bible” of chart patterns, Bulkowski’s The Pattern Site, “symmetrical triangles have a tendency to double bust — the final breakout direction is the same as the original one.”

The fact that most commentators see patterns busting is that they fail to take the phenomena of fractals into consideration; in other words, these commentators look at charts in only one time horizon without taking into consideration that all patterns are actually the actualization of a stream of continual changing market emotions and psychology. It’s when a general consensus begins to take hold (either a positive or negative one) that a breakout occurs and a new trend is established. Until that happens, the stalemate continues and one pattern morphs into another and another and another.

Rather than looking at two or three week’s worth of trades through a magnifying glass and seeing (creating) a “pattern”, it’s better to take a longer-term view and see where all the potential boundaries of this congestion of equilibrium might be:

S&P 500 11/17/11

To proclaim that the symmetrical triangle had been broken and a major move down had therefore begun is ludicrous. It ignores the following realities:

  • trendlines aren’t concrete structures. They are only a visual representation of the chartist’s belief as to where one a boundary might be
  • rather than being lines, boundaries are actually zones, a range of prices where the struggle for control changes
  • there can always be tail-end moves, crosses of trendlines that are nothing more than an atypical expression of momentary extreme optimism or pessimism. Until proven that the psychology of the majority or market participants has changed, the stalemate continues (and the symmetrical triangle pattern morphs into another pattern … perhaps a horizontal trading range channel?)
  • it’s understandable that since it’s jammed between two earlier larger patterns (the head-and-should reveral and the summer’s horizontal trading channel), those equilibrium situations have to be resolved before a new extended trend can start.

True the lower boundary of the symmetrical triangle was violated but there are still several other trendlines that act as resistance against a major downside move. Most of the bad news coming from Washington and Europe has already been reflected in the market and there isn’t sufficient consensus for the launching of a new bear market. If anything, the surprise could be from a new positive development from some unexpected source.