AAL Preparing for Wave 5 Impulse

When we last discussed American Airlines Group (NASDAQ: AAL) on 8 December 2016 (The Grape's Vine: Bearish Harami and RSI Divergence Urge Caution with AAL) the stock was signalling weakness at what appeared to be the top of Elliott Wave 3.  All indications at that point were for a consolidation in Wave 4.  That analysis turned out to be correct, and the remainder of December was spent in a flat a-b-c consolidation.

AAL Daily Chart

At present, Wave-4 is trading right at the 23.6% retrace line of Wave-3.  This is a nice, shallow retracement as compared to the steeper Wave-2 pattern, so the alternation rule is satisfied.  It's also important to note that the of of the current Wave-4 pattern is right at a short-term support line formed by the top of the prior Wave-iii, and it's also sitting on top of the 30-day Exponential Moving Average.  Those three support levels, when combined, form a much stronger level of support than each of them would individually.

Continuing the Elliott Wave analysis, Wave-3 is longer than Wave-1, so we don't have to worry about any rule constraints that may hinder Wave-5 development.  Now, Wave-3 was an extended wave, so it's unlikely that Wave-5 will also be extended.  There's no rule preventing it, but it would be an uncommon occurrence should it occur.  Suffice it to say that I'm not counting on it in the reward to risk calculation.

As we expected - and documented in the 8 December post - the RSI(9) oscillator did indeed form a bearish divergence.  In fact, that has developed very neatly into a bearish channel that may prove to be a good entry indicator. 

Also of note, On balance Volume started to rise steadily off its lows in the middle of Wave-3, and it continues to do so.  The lows were reached at the bottom of Wave-ii, and the indicator has climbed ever since.  Even the Wave-4 consolidation did little to halt the upward climb of OBV.  This is a pretty good indication that the stock is under accumulation.

The weekly chart does little to change our current view of the stock:

AAL Weekly Chart

The Elliott Wave count is much clearer and virtually indisputable on the weekly.  Additionally, there appears to be a bull flag in development on the weekly chart, adding some strength to the projections of an upward move.  The bull channel in which the entire impulse is trading also shows plenty of room for growth.

From the weekly chart, it's easier to confirm that Wave-3 is longer than Wave-1, and from there, the projections for Wave-5 are easier to visualize.  Now, please keep in mind that, of all of the waves, Wave-5 is certainly the most fickle.  By the time we reach the fifth wave in the impulse, the institutions and the specialists already have their full allotment of shares, so the buying that's pushing the stock higher at this point is primarily public enthusiasm.  That can deteriorate rapidly, which is why it's not at all uncommon to see a truncated Wave-5 that doesn't meet the optimistic projections Elliott Wave theory would like us to believe.

So how are we trading this stock?  Well, keep in mind that tomorrow is the last trading day of the year, which means I do not plan to open any new positions in 2016.  Whether or not I open any on January 3, the first trading of the year, is doubtful as well.  We need to see how the start of the new tax year is going to manifest since there may well be a lot of profit taking in early January as traders anticipate a better tax rate structure under the incoming administration.  So the earliest I'm looking to open a new position is 4 January 2017.

Strength breaking the diagonal line forming along the highs of the last six trading days (not drawn, but I'm sure you can see that line) will be the signal to go long.  To be conservative, we're going to target the 61.8% extension line (shown on the weekly chart) in our reward to risk calculations.  Given the strength of resistance at the double-top pattern on the weekly back in January through March 2015, there is a good probability that AAL will reach that level again, however we don't want to count on that in our calculations.  We will trail our protective stops rather loosely, since we do want to catch as much of the Wave-5 move as possible, until we hit that 61.8% line.  At that point we'll tighten them and continue to follow the stock up until we're stopped out of the position.  AAL reports earnings on 27 January, and they're not expected to trade ex-dividend until early February, so there's nothing imminent that could derail the analysis, barring the unforeseen, of course.

It's time now to start assessing our trading strategy for the first week of the new year, but as I've said, it's too late in 2016 now for me to consider new positions until we see what the new tax year will bring.

Happy Trading.