Solanezumab Failure has Eli Lilly Down But Not Out

Disclaimer: This article is not a buy or sell recommendation.  You must do your own analysis and consider your own risk, money management, and trading strategy before placing any trades.

Pharmaceutical giant Eli Lilly and Company (NYSE: LLY) suffered a serious blow, yesterday, with the announcement that their premier Alzheimer's drug Solanezumab failed Phase III testing.  The latest study failed to demonstrate a statistically significant improvement in the slowing of cognitive decline as compared to a placebo.  Shares of LLY plummeted over 11% at the open.  As a result of the study, Eli Lilly is also taking a step back to assess the status and progress of other Alzheimer treatments they currently have in their development pipeline.

The tale-of-the-tape, however, shows some serious potential for traders in all time frames.  Let's examine the weekly, daily, and hourly charts for LLY to see what information we can glean.

LLY Weekly Chart

 Let's start with the weekly chart.  A selling climax in September of 2012 ended the prior consolidation period for this stock and started the bullish impulse wave that continues through today.  The weekly pattern has thus far traced three well-defined Elliott Waves (marked (1), (2), (3) respectively,) and is currently in Wave (4). 

As of yesterday, we've retraced 61.8% of Wave (3).  The alternation rule is satisfied since Wave two was short and relatively flat - only about a 38% retracement of Wave (1).  Given the weekly pattern, we can expect a resumption of the bullish impulse into a Wave (5).  Since Wave (3) is longer than Wave (1), there are no restrictions on the height Wave (5) will travel, although it will typically run between 68.2% and 100% of the length of Wave (1).  If yesterday marked the end of Wave (4) - and to be clear, we do not know that, yet - then we have a minimum price target range of 79.25 to 88.77.  Note the caution sign, however.  There is very heavy resistance around 71.00, so once the uptrend resumes, we can expect a bit of a pause and consolidation at that level.  What this chart does tell us, though, is that there should be another bullish impulse coming, and there's potential for price movement between $15 and $24 to the upside.  Since we're looking at a weekly chart, however, do consider that the time-frame for the full Wave (5) move is approximately 20-months.  Playing all of Wave (5) is not a short-term strategy.

LLY Daily Chart

Now let's turn our attention to the daily chart.  This is the chart we use both to assess potential trades and to plan exit strategies.  The methodology we follow uses three charts - the daily for the overall setup and strategy, the weekly for the long-term trend of the stock or market, and the hourly for the entry strategy.  So what is the weekly telling us?

First, it tells us that the bad news really came as no surprise.  Look at that nice double top pattern that developed in August and October, and look at the swift and steady decline that followed the failure to retest those August highs.  Sure, we had a bounce in November - the entire market had a bounce in November, but the volume on the bounce was very lackluster.  It doesn't come close to the volume we saw in late June when the stock covered essentially the same ground on its way to the August high.  What can we conclude from this?  The smart money had an inclination that bad news was on the horizon and they gradually turned shares over in preparation for it.  Their long-term plan suddenly comes into focus when we look at the hourly chart, but more on that later.

The gap up last week was on better than average volume, but as we saw the next day, it was unsustainable.  A test of that high failed, and the stock meandered downward in a lackluster fashion for the next week.  The behavior and pattern strongly suggests that the stock would close the gap before much longer.

Notice, however, that red line I've drawn on the chart.  Prior to yesterday, we'd have expected that line to represent a very strong support line, and we would have played a long position on a test of that line.  That line represents the 38.2% retrace of the entire Impulse, the 50% retrace of Wave (3), and the 50% retrace of yesterday's gap.  With traders in all time-frames spotting significance at that level, we can expect a period of consolidation and testing as price approaches and attempts to penetrate that line.  Of course, following yesterday's gap, that's no longer a major support line but is now a major resistance line.  Either way, we can play it.

LLY Hourly Chart

Finally, let's look at the hourly chart.  In this case, it not only helps us plan an entry strategy, but it also gives us insight into what the smart money - i.e. large institutions and market makers - are doing.  Remember, the market maker is almost always on the opposite side of the retail trader, but if we want to profit, we need to be following, not opposing, that market maker.

So what did the smart money do, yesterday?  The went bargain hunting and bought a tremendous quantity of LLY throughout the day.  The navy blue line represents yesterday's open.  Now, normally, I ignore volume on an hourly chart, but yesterday's can't be dismissed.  Look at the candle and the volume in that first hour.  There was so much demand at that point that the stock moved over 2 points upward in the first hour.  That trend continued through lunch before the bars narrowed and price settled into a narrow range.

Going into the last hour, the stock had gained almost 4-points from the open.  The last 15-30 minutes of trading normally sees extremely high volatility as day traders close their positions.  You can glean a lot of information in that period.  Wednesday's close was particularly significant since the market is closed today for Thanksgiving and tomorrow has a 1:00 PM close.  Many traders turn it into a 4-day weekend, and volume will be extremely light tomorrow.  As a result, short-term traders - both day traders and swing traders alike - do not like to carry risk through the close on the Wednesday before Thanksgiving.  Too much can happen before the market opens on Monday.

Did we see the smart money unload their shares yesterday afternoon?  Not even close.  Oh, it was slightly down in the last hour, but you'd expect that.  The range, however, was extremely narrow, and the volume was en par with midday.  The smart money not only held onto their shares, but they also kept price in a very narrow range.

So, how are we going to play this stock?  There are numerous potential strategies that could play out: 

1.  A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with a downward breakout.  If that happens, then we'll be looking to play a short when the flag or pennant is violated.  Our price target in that case would be 53.75. (I normally set the target at 76.4% of the height of the flagpole, either adding it to or subtracting it from the violation price depending on direction.)
2. A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with an upward breakout.  If that happens, then we'll play a long position when the flag or pennant is violated.  Our price target would be 78.84, although we would expect that to be a five sub-wave impulse that we'll likely play separately.  
3. Without a flag or pennant pattern developing, we'll look to play a sustained break of yesterday's high with a long position, setting the target at 70.75, just below that major resistance level.  
4. Once price is playing around that resistance level, we will watch for two things.  If there is a second failed test of that resistance level, then we'll play a short back down to yesterday's low.  If, however, a second test succeeds and it's penetrated, then we will wait for the stock to drop back down to that resistance line in a retest.  At that point, we'll look to go long  with a target back to around 76.50.  (Notice the resistance lines forming at that level.)

You'll notice that we're not looking to play a short if yesterday's low is taken out unless that happens following a flag or pennant.  Due to yesterday's decline, there's a 4-day short-sale restriction in effect, so we have plenty of time to assess  any plays to the downside.  Until mid-next week, the only plays are up, and that's just fine for now.  Once that short-sale restriction is lifted, however, be cautious of a downside surge that could produce a price trap.

However you chose to play this, be sure to determine your exit strategy in advance.  One of the primary rules of swing-trading is to know how you will exit the trade before you ever enter the trade.

Happy Thanksgiving!