Saturday, December 24, 2016

Descending Triangle in COP Hints at Upside Strength

Conventional wisdom for descending triangles is that they are bearish patterns that produce lucrative downside trades.  Reality, however, is that a breakout can occur either way, and that breakout - in the short term - can be lucrative regardless of the direction.  As we head into the final trading week of the year, we're seeing just such a short term pattern in ConocoPhillips (NYSE: COP) and the current signal is hinting strongly at an upside break in the short term.

COP Daily Chart
The current triangle started with what appears to be a continuation gap on 12 December.  From that point, the stock has traded in a tight sideways pattern that appears to be setting us up for another significant short-term move.  There are two words of caution here, though.  While I call it a continuation gap, there's the potential for it to be an exhaustion gap.  The stock did gap up with gusto at the open on the 12th and it pushed to news highs before retreating significantly to close well below its open.  A true continuation gap should have a close in the direction of the gap, not opposed to it.

Additionally, a long-shadow on the 15th briefly closed the gap.  That trait is also not typical of a continuation gap, and it does give us pause when considering the significance of the gap itself.  Instead, we'll focus on the other subtle hints that the chart is offering. 

The base of this triangle formed at a very strong line of support that dates back to October 2015.  Notice that it served as strong resistance in a pullback on 15 December 2015.  That COP broke through this line with a gap and has held the line on eight consecutive days is a message we can't ignore. 

The next bit of evidence is a bullish channel marked in dashed green lines.  The slope is clearly established at the bottom of the channel with three well marked touches.  Extending that line to the top of the channel also produces three clear touches, and the two days surrounding the gap appear to transform that upper boundary into a support line.  We can see how that line held on 15 December, in fact.  It's important to note that we closed right on that line on Friday.  Now, volume on the last trading day before Christmas is historically light, as is trading the week between Christmas and New Years, so some caution is needed when reading any signals that may arise over the next four trading days.

Let's turn out attention next to the 52-week high-low Fibonacci retracement levels. After bouncing around between the 38.2% and 61.8% level for a good eight months, the latest surge pushed COP above the 76.4% level where it has remained.  That in itself is considered a bullish move and is a major signal that the downtrend was successfully reversed.

Given the strength projected for oil in the coming year, strong guidance from COP, a major oil production deal from OPEC, and a rising US Dollar, we believe the signals from COP are to the upside.  The company completed planned 2016 distributions, generating $1.3 Billion in revenue, well above it's original $1 Billion target.  Taking those distributions into account, the forecast for 2017 is still encouraging, with up to 2% year over year growth in the offing.  Additionally, they started their planned $3 Billion share buybacks in November, adding further strength to the underlying issues.

COP is now on our watch list for a potential long trade.  What we need to see, however, is confirmation that both the major S/R line in bold-dashed blue and the upper channel line in dashed-green will hold.  We also need to see a close above the hypotenuse of the triangle on convincing volume (seasonably adjusted.)  You can see on the chart that I've added the Fibonacci lines that mark the section from the triangle base to the 52-week high.  A reasonable price target for that upward break is the 76.4% extension at $55.78.  That line corresponds to a horizontal resistance level (not drawn) going back to that consolidation region from October to December 2015.

Throughout this period and into the beginning of 2017, it's important to keep the broader market in mind as well.  We're starting to see a bit of a pause in the strong uptrend that's characterized the market as a hold since the US elections in early November.  How the market will behave after the first of the year is anyone's guess at the moment.  A post-inauguration pullback - or even a correction - is likely, given the strong run that ended the year.  The point is, watch the broader market and be sure the broader market is moving in the right direction should COP breakout shortly.  A trade counter the broader market will likely fall short of price projections and could adversely effect our reward to risk positioning.  It's something to keep in mind as we watch for a break.

Happy Trading.

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