Mattel Forms Hammer on Strong Volume

Following a double top at their 52-week high on 18 April 2016, Mattel (Nasdaq: MAT) spent the remainder of the year trading in a horizontal channel that spanned about six points from low to high.  After tightening that channel nearer the low end over the last two months, Mattel signaled a break off the bottom trendline in today's trading.

MAT Daily Chart

The hammer candle that formed today did so at the 10-month low for the stock.  Now, as candlestick patterns go, the hammer (when formed at a major low) produces a bullish reversal approximately 50% of the time.  That statistic is much better than it sounds, however.  Consider that there are three possible outcomes from this position.  The stock can trade sideways, it can drop further, or it can rise from here.  To put that in perspective, there's a 25% chance it will drop, a 25% chance it will trade sideways, and a 50% chance it will rise.  That candlestick pattern suddenly sounds much more reliable, doesn't it? 

Of course, we never enter a trade simply based on a single candlestick pattern.  We need to consider the rest of the chart and determine if there are other elements that confirm the move and increase the probability of a successful trade.  One such factor is volume.  When you look at the chart, we see the second highest volume pattern since mid-June.  That implies demand - a lot of demand - entered the scene as MAT reached its low for the day.  Our odds suddenly got much better.

Look at the Fibonacci retracement grid drawn from the low to the high on the overall chart pattern.  The long tail in today's hammer just penetrated the 38.2% retracement level.  For stocks trading in a horizontal pattern as long as this one has, that's a very significant retracement level.  It would be safe to conclude that there were many limit orders to enter long positions just below that 38.2% level.  It would also be safe to conclude that there was a significant amount of short covering at that level, as well. 

Notice next the support/resistance line (dashed blue) right at our open today.  We broke below it for much of the day, but what's significant is that we pushed back above that level and managed to close not only above our open, but near the high for the day. 

Not shown on the image in this article are the RSI(14) and Slow Stochastic(14,3) oscillators.  Now, I don't enter positions based on technical indicator signals, however they are extremely valuable in adding confirmation to what the chart is already telling us.  In this case, the RSI(14) broke back above 30, today, and the Slow Stochastic(14,3) had a bullish crossover below 20, today.  Those are two extremely bullish signals on top of a chart that is already telling is to go long.

Now, this is a swing trade, not a long term position trade.  We are looking at a brief move of perhaps a week or less.  You'll notice two parallel dashed lines drawn in green.  Our target is that upper green line, and you'll notice that it's sloping down.  We're looking at about a two-point move at most, and this is a trade we need to exit at the first sign of trouble.  Since it's a pure momentum play, our stop is going to be just below the lower channel line, not below the low of today's hammer.  That increases the risk that we'll be stopped out of our trade for a loss, but if this stock doesn't take off immediately then the signal is invalid and we want out quickly, anyway. 

So that's the overall play.  We'll monitor futures before the open, and then watch the market for the first twenty minutes.  We want the market moving in our direction, and if it is, we'll enter the trade with a stop limit order between 29.61 and 29.66 with a start time of 9:50 EST.  (Meaning, we won't enter a position before 9:50 EST.  It's too easy to get caught up in the extreme volatility of the open.)  Our protective stop will be 28.98, and our price target will be 31.66.  That gives us a 2.88:1 reward to risk ratio.  It's a hair under the 3:1 we prefer, but it's still a solid gain. 

If we are not stopped out during the day, tomorrow, we'll look to adjust our stop to breakeven as soon as is practical.  This stock has tended to move quickly off its lows in the channel, however our objective is always to first identify risk, reduce risk, eliminate risk, and then protect any profits. Let's see how this one develops. 

Happy Trading.