Friday, December 09, 2016

KHC Forms Double Bottom With RSI Bullish Divergence

Kraft Heinz Co. (Nasdaq: KHC) provides an excellent study in multiple chart patterns and signals.  The most current pattern under development appears to be a double bottom with lows on 14 November and 6 December 2016.  If confirmed, the double bottom is fairly reliable bullish pattern, although due to the growth in popularity for this pattern, more caution is needed when trading it.

KHC Daily Chart
First up on the chart is an interesting diagonal support line (in dashed green) that started out as resistance in early April.  Since that line was broken with an significant gap up at the end of April, it served as a very reliable support line until November.  We can also see that a horizontal resistance line (also in dashed green) formed in early September.  The combination of the two produced a very tight ascending triangle pattern that I've highlighted in pink.

The documentation you'll find on the ascending triangle will tell you it's a bullish pattern and to anticipate an upward breakout.  That has not been my experience, especially when there are as many touches of that resistance line as seen in KHC.  A bullish breakout requires demand, and my experience has been that the most profitable plays in a triangle is to the side of the hypotenuse, not the resistance leg. 

That certainly came to pass with KHC.  The downward break was swift and it hit the price target for that break in a single day.  The subsequent retest of the diagonal - now a resistance line - was equally profitable with another rapid retreat back to the price target level of the triangle.  Two nice profitable plays for the price of one.

This now sets up our next pattern - the double bottom.  Once again, most books and websites will list the double bottom as one of the most reliable trading patterns.  At one time, it was.  Unfortunately, the setup has become too popular, and market specialists now engage in enough stop hunting that a pullback following the pattern breakout is more the norm.

The actual confirmation of the double bottom is when price closes above the neckline of the pattern.  I show that level on the chart with a thick, dashed orange horizontal line.  What's very common now, though, is for price to break above the neckline, trade there for a few days, and then quickly retreat back below the neckline as the specialists trap the retail traders on the long side.  If you're an aggressive trader, you can play that, keeping your stops tight.  Grab the quick upside profit, wait for it to retreat, and then go long again on a second break of the neckline.  That second break is often the true move.

Returning to our chart, though, notice that the double bottom has formed at the 50% retracement level of the overall uptrend.  That's an extremely strong support line, especially since it coincides with the highs of October, 2015 and with the top of the congestion pattern  from March to May 2016.  A retreat to the 61.8% retracement is possible, but there's a lot of support to overcome for that to happen.  The bounce off 50% is a bullish signal.

Next up is the volume pattern.  We have rising volume as ranges declined into the second bottom.  A high volume day on a long white candle coming off that bottom is a very bullish signal.  The day following was an inside day, creating a bearish harami setup, however the requirement that the bearish harami occur on a strong downtrend was not satisfied.  Therefore, we're interpreting the inside days as a bit of a pause following that high volume up day, but we're not interpreting it as a reversal.

Finally, we see a bullish divergence in the RSI(9) oscillator.  The RSI has traced higher lows in each of the major lows on the chart since early November.  That's an indication that a bullish reversal may be imminent, and that sentiment is consistent with the double bottom pattern that we're currently watching.

The target price range for this pattern sits between the 61.8% and 100% extensions above the neckline.  (We measure the height of the neck from the low of the double bottom and set a Fibonacci grid based on that height starting at the neck.  We expect price to at least reach the 61.8% extension before pulling back, although a 100% extension is also common.)

Keep in mind that the pattern is not confirmed until there's a close above the neckline.  We can trade the rise to that neckline, of course, however that's a higher risk trade than is the rise from the neckline.  Be sure to factor that into position sizing.

Remember, too, that busted patterns are also profitable.  A break below the low of the double bottom is an excellent shorting opportunity.  There are a series of support lines (not drawn) that offer target guidance, however remember that downside moves tend to be swift and steep.  (Look at the downside move out of the triangle as an example.)  As we watch this - or any - stock for the development of the primary pattern we wish to trade, always keep an eye out for an opposing trade.  Often, it's the breakdown of the pattern we're stalking that proves to be the profitable play.  Avoid being so rigid in the analysis that we miss the true trading opportunity.  Keep an open mind, and play the setup that develops.

Happy Trading.

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