Thursday, July 14, 2016

MOS Breaks Upward Out of Descending Triangle But Warning Signs Abound

We started tracking Mosaic Co. (NYSE:MOS) for a potential breakout on June 19th.  The stock finally pierced the pattern with an upward breakout yesterday (7/13) that continued with strength today.  You'll note from the chart that there were two other false starts (also upward) on June 7th and again on June 23rd.  Neither of them were a valid signal, however, since both immediately fell back into the pattern the following day.  Yesterday was the third penetration of the trend-line and, since there was strong follow-through today, this appears to be the valid break-out.

MOS Breaks Upward From Descending Triangle
Despite having followed this pattern for close to a month, I'm going to sit this one out.  There are some warning signs on the chart that suggest that there's possibly very little room to the upside.  Here's why:

  • The standard "measure rule" in a descending triangle offers a profit target of the height of the triangle measured from the breakout point.  That would give us a target of $33.38 with a stop at $24.39 (just below the bottom of the pattern.)  Our entry would be $28.68, just above today's high.  Now, an aggressive trader could place a stop around $26.99, which lowers the risk, but when I count 6 unique touches of that bottom trend-line, I'd be concerned that a pullback would easily take out that aggressive stop. 
  • That brings us to the reward vs risk ratio.  The conservative stop only gives us a ratio of 1.08:1. The aggressive stop is much better with a ratio of 2.76:1, however as I said, I'm very concerned about the probability of that stop being taken out prematurely.  The 1.08:1 ratio is a non-starter.  The number of winning trades needed at that level are much higher than even a professional trader can consistently achieve.
  • The profit target assumes we hit 100% of the estimate.  That only occurs about 60% of the time, however, for a descending triangle breakout.  A more realistic target would be $31.17 which is the 61.8% Fibonacci extension of the height of the triangle.  That brings our ratio down to 0.57:1.  There's also a weak resistance line at that level based on the high of the triangle.  That increases the probability that we'd never hit the 100% estimate.
  • Today's candle forms a double-top with an almost identical candle that formed June 23rd.  In both cases, the price stalled at the 23.6% Fibonacci extension.  A double top is a bearish pattern that, in this case, has a price target of $20.53.  That, coincidentally enough, meets the 61.8% Fibonacci extension of a downward breakout from the triangle.
  • The real killer for this trade, however, is an extremely strong resistance line at $26.91.  That coincides with the 38.2% extension, and it's formed by a low on October 2, 2015, passes through the highs of the triangle pattern, and halted an advance on April 21, 2016 as well as June 7, 2016.  It's a very strong area of resistance and, in all likelihood, the current breakout will stall at that level.
We'll keep MOS on our watch list, despite the fact that we're not taking the trade that setup yesterday.  The reason is that, if it does reverse and fall back into the pattern, there's a much higher probability that it will penetrate the support line at the base of the triangle and then resume the down-trend that has plagued this stock in stages since early 2011.

The other potential short that we will watch for is a break back into the pattern.  At that point, if the market is similarly retracing, we can enter short and ride it at least to the bottom of the pattern, if not beyond.  The way the overall stock market is surging this week, however, we'd only enter that play if the market itself pulls back and begins a downward retrace.

Remember, always stalk your trade.  We're under no pressure to enter a position ahead of its time, and when we do commit capital we always want to do so when the odds are stacked in our favor.  The moment those odds turn against us, the smart play is to revert to cash.  When it comes to MOS, that's precisely what we will do.  Cash is a position, and in this case, we believe it's the right one.

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