Is Southwest Poised to Soar or Crash and Burn?

Like most stocks appearing on our radar, this week, Southwest Airlines, Co. (NYSE: LUV) experienced a steep climb off significant lows for much of the fourth quarter only to stall in the final ten-days before Christmas.  In part, that's due to the type scans I execute when searching for candidates, however it appears to match the overall trend of the market as a whole.  Momentum definitely waned through the second half of December.

LUV Daily Chart

Southwest is clearly on the cusp of a move.  The direction of that move, however, is not yet clear.  We can see that there was historical resistance at these levels, going back to the 7 December 2015 shooting star high.  The decline that followed that one was significant, and it set the stage for the broad trading range LUV has endured ever since.

That trading range was finally violated after a tight congestion pattern in November.  The breakout was a high range white closing Marubozu candle on 7 December 2016.  Notice, however, that volume did not confirm that breakout.  It barely reached both the 50 and 200 day volume moving averages.  Sure enough, there was very little follow-through on the breakout.  The stock did amble upwards a bit from there, however the longest body turns out to be a bearish signal with a long wick at the high set a year earlier.  The volume that accompanied it may be symptomatic of climactic action.

The volume signature in general shows a loss of interest at this level.  Now, some caution is required since volume in general wanes significantly over the last two weeks of the year.  For now, though, we really can't ignore the sharp volume decline starting 19 December.

There are several trend-lines that appear significant (all marked in dashed green lines,) however, and all of them offer support at this level.  Let's review the three of them moving from top to bottom.

The uppermost trend-line is a good example of a pivot line where resistance transformed to support.  The short-term resistance line started in late November and only had two touches, however it did follow the slope of the pattern right up until the 7 December breakout.  After that, it provided support on the first downward retest and has followed the slope of the gradual uptrend that marked the remainder of the period.  If we experience a downward breakout, this line may offer a support and consolidation area.

The middle trend-line (counted from the starting point, not its current location) is also a pivot line.  Serving as resistance, this line has multiple touches going back to early September.  The test of the line on 24 October resulted in a steep exhaustion gap down that actually generated the beginning of the current uptrend.  Notice how the line was finally penetrated with confirming volume on 14 November.  From there, it's provided support with two additional touches before the final breakout.  This line may provide another significant area of support in the event of a downward breakout.

The final trend-line marked in the darker dashed green line is drawn from the bottom of the current trend through the bottom of Elliott Wave 2.  It's a very steep slope, thanks to the near-vertical wave 1, and given that slope it's not likely to offer much in the way of support.  We may find out shortly since the low of the candle on 23 December rests right on this line.

An additional support line for which we must account is the 10-period EMA (Exponential Moving Average.)  Notice how the lows have ridden this moving average through much of the current impulse wave.  A close below that moving average may well signal a significant downturn.

The range between $48 and $47 will likely be an area of consolidation should we break to the downside.  Two significant Fibonacci retracement lines from two different points of origins provided  either support or resistance in that range already, and there's recently been a lengthy consolidation period within that range.  If playing a downward break, that range must represent a conservative price target since it may be difficult to breach in a short-term pattern.

One final datum point to consider is the bearish divergence pattern in the RSI(9) oscillator.  That divergence is not the result of the low-volume influence in the last week before Christmas.  Rather, it started with the bearish spinning top on 15 November that marked the top of Elliott Wave 1 in this count.  This divergence adds strength to the assessment that momentum has waned.

I should note that there's an alternate Elliott Wave count that could end up being correct.  In that count, what's currently marked Wave 1 would actually be a Wave 3 completion, and 15 December would be the top of Wave 5.  That would mean that we're currently in the midst of a post-wave 5 corrective pattern.  At the moment, either count could be correct, hence the uncertainty as to LUV's direction from here.

Southwest next reports earnings before the open on 26 January 2017.  Their October release explains a bit of the uncertainty in direction from here.  The computer troubles they experienced took a significant bite out of their quarterly revenue, and Hurricane Mathew didn't help matters, either.  The compressed holiday season will impact all airlines this year, and in the markets served by Southwest the final arbiter may well be Mother Nature.  Southwest has some interesting plans for 2017, including the introduction of flights to Cuba and a new route from LAX to Mexico.  They are also replacing their aging 737 fleet with the newer 737 Max aircraft, and a new reservation system is going live in the new year. 

The company outlook for 2017 is rather optimistic, however our interests are short-term, not long.  What we are watching is two-fold.  A close above the high set on 7 December 2015 with confirming volume will be our signal to enter long.  At that point, we'll be setting a price target equal to the length of our labeled Wave 1 as measured from the bottom of Wave 2.  That would still give us at least a $3.75 move from that breakout point, with a stop just below the tops of the current consolidation range.

A downward break, on the other hand, would be marked by a close below the EMA(10) line, again on high volume.  We'll have to tread carefully with that, however.  To enter a short position here, the overall market will need to also signal short.  There's too much support nearby, and the target range of $48 is a bit too close at the moment, so the reward vs risk analysis will likely prohibit a short entry.  What it will do, however, is demonstrate which Elliott Wave count is correct, so while it may inhibit a short entry now, it will likely provide several additional trading opportunities that will prove lucrative.

Let's add this stock to our watch list and see what develops.  Remember, however, that we need volume to confirm the move, and volume may be hard to come by until after the New Year.

Happy Trading.