DHI Signals Short Term Bull Channel Trade

DR Horton, Inc. (NYSE: DHI) approached the lower (20,2) Bollinger Band on very high volume, bouncing off to produce a long-tailed spinning top in today's trading.  The significance of the high volume is somewhat diminished by today's quadruple witching, however the remainder of the chart shows promise for a short-term long play.  Let's first take a look at the daily chart. 

DHI Daily Chart

The price action on 9 November penetrated both the lower Bollinger Band and the 61.8% Fibonacci retracement from the 52-week high to low pattern.  Of significance, however, was the immediate bounce back to the 50% level where a very strong pivot line has already been established.  Since then, we've found support at that 61.8% line on two additional tests. 

Both the highs and the lows in this six-week pattern have created a well-defined bull channel, albeit with a modest slope.  Today's price action marked the third test of that support line, but we'll take a much closer look at that test shortly.

From the daily chart perspective, we're now looking at a potential short term channel play.  The RSI is confirming the short-term bullish signal, so there are no worries there.  The higher highs and higher lows are also encouraging, as is the volume in today's action.  Remember, though, that the volume was influenced by quadruple witching, so we do need to downplay it just a bit.

To get a better feel for today's action, and to analyze a potential entry and protective stop range, we'll turn our attention to the 30-minute chart.  (I prefer 30-minute charts to the 60-minute chart since the open and close volatility fits neatly into one candle on each end and isn't potentially hidden by doubling that cycle.  Also, the trading day is 6.5 hours long, so there's an inconsistent overlap of alternating days using the 60-minute.  I find the analysis works better on the 30.

DHI 30-Minute Chart

Well, the very first thing that pops out as us is the long tail.  That certainly caught our attention on the daily chart, but here we see that it occurred right in the first 1/2 hour of trading.  That has all the hallmarks of some stop gunning.  It's the type pattern you'll see if the specialists are taking out sell stops in preparation for a move upward.  For the rest of the day, the stock traded in a narrow range that created a bull pennant with the long tail acting as the pole.  Volume at the end of the day was high on a very short candle, but given today's options expiration, that's not a surprise.

Notice that, just like the daily chart, the 30-minute chart is also hovering right at the 61.8% retracement level from the 52-period high-low pattern.  There is also a very strong horizontal pivot line (in dotted bold blue) that is now acting as support.

The 30-minute chart is providing a potential entry zone as well as a good protective stop level.  For the entry, remember that we don't enter a position before 10:01 EST.  You can see on this chart how volatile that first 1/2 hour is, and it's the territory primarily of the market specialists, day traders, and scalpers.  I prefer to let the market settle down a bit and enter after we can see the true direction it's taking.  So 10:01 is the earliest I'll enter a position.

The range we'll set for entry, based on this 30-minute chart is from 0.10 above the upper pennant line to 0.10 above the height of the full flagpole.  Above that and the reward to risk ratio is too low, and below it invalidates the signal.

There are three potential stop loss levels depending on how aggressive you are as a trader.  The first obvious level is just below the pennant.  That level is a bit too aggressive for me, however, and I believe it's an area likely to be taken out if there's still some stop-gunning on the horizon. 

The second level is what I've highlighted in red.  That area forms support from the two-day pattern, and that nice rounded bottom heading into Thursdays close appears to be a solid bottom.  In fact, that's likely what prompted the specialists to go stop hunting at the open, today.  Now, that level is still somewhat aggressive, however as long as we avoid the first 30 minutes of trading, we may well avoid another stop-hunt at that level.  So personally, I'll set a stop just below that red line.

The final level, of course, is below the low of that long shadow.  That's the most conservative level in this short-term pattern, and for me it's too conservative.  The distance we'll have to travel to get a decent reward to risk ratio is more than I can comfortably plan.

For our exit strategy, we return again to the daily chart.  Remember, we take our signal from the daily, select our entry and stop from the 30-minute, and then exit based on the daily.  As we can see on the chart, there's a very strong resistance line (in light blue) that coincides with the upper Bollinger Band.  It is also intersected by our bull channel in three trading days.  That's where we'll set our price target. 

This is a pure channel play, so we must be prepared to exit at any sign of weakness.  We also need to be aware of that intermediate pivot line that sits dangerously close to the center of the Bollinger Bands.  There's a risk of pausing or retreating at that level, and we must remain nimble enough to recognize it and exit immediately.  This is a two or three day play, not a long-term play, so we can't afford to sit around and wait for a consolidation to work itself out.  Exit immediately on any weakness.

Happy Trading.