Sunday, December 04, 2016

What To Watch As IDTI Lines Up For Next Move

As I've mentioned previously, one of my favorite setups is a long lower shadow (preferably a hammer) following a down trend, or a long upper shadow (preferably an inverted hammer) following an up trend.  When found at the potential top or bottom of a trend, both of those candles signal a potential trend reversal if they are accompanied by high volume.  When volume does not confirm the pattern, however, a much deeper analysis may be needed to determine what is truly happening with the stock.

Integrated Device Technology, Inc. (Nasdaq: IDTI) appeared on my scans this morning, and it prevents a fascinating study with multiple options setting up over the next week.  We'll add this stock to the watch list and keep an eye on it since the setup for the next move has only started to develop.  Let's take a look at the daily chart to see what it can tell us.

IDTI Daily Chart
We can immediately see that, following a major gap down on 2 February 2016, the stock traded sideways for the remainder of the year.  The gap was closed several times however no upward breakout was sustainable.  The major pivot point, interestingly enough, is the 50% retracement from the pattern established with the 3 December 2015 high and the 11 February 2016 low.  Thus far, attempts to push above that 50% retracement have been brief and unsustainable.  Thus far.

With that in mind, let's look at the two major setups that we see, one forecasting a move to the downside and the other a move to the upside.

Setup One - Flag Development with Downside Break.

Could we possibly ask for a better flagpole setup than we have starting with the high of 25 November to the low of 2 December?  The low ended with a long-shadow candle, but on lower than average volume.  It wasn't quite a hammer - the wick is a bit too long for me to call it a hammer - but the implications of the long shadow remain the same. 

Remember that pivot point at the 50% retracement?  Well, that's precisely where we sit right now.  Two consecutive long down candles on high volume pushed us back below that 50% level, but unlike the three prior tests of that major support/resistance line, we've immediately retested it with a bullish candle pattern with a long shadow.  That long shadow indicates demand coming into play at the low.

Another major significant pattern to note is that the 2 December retest starts at the bottom of a significant congestion range that ran from 1 November to 11 November.  The bottom of that range was formed with a gap up on 1 November, and it has thus far proven to be a significant line of support.

What we are watching for now is the strength of signals over the next week.  There is a very good possibility that we will trade in another tight horizontal consolidation range bounded by the two thick purple lines drawn on the chart.  Coupled with the flagpole that ended on 2 December, that would create a classic bearish flag pattern.  Given the height of the pole, I'd really like to see at least 4 bars in the flag, and no more than 7 for it to remain a valid pattern.

A downward break following a 4 to 7 day consolidation would set a price target of between 18.69 (the 76.4% extension of the flag pole) and 17.59 (the 100% extension of the flag pole.)  Notice that the 18.69 target sits right smack on top of a support line also created by a brief consolidation period from 3 to 12 August.  If we do break to the downside, that's the likely destination for price.

Watch for this pattern to develop, however it's important not to jump the gun on a trade to the short side.  For this setup to be valid, we need to see that 4 to 7 day congestion period for the flag followed by the break to the downside on high volume.  Don't ignore the volume.  We need it for confirmation of the break to differentiate between a legitimate move and a potential bear trap.

Setup Two - Mirrored Pattern Development with Upside Break.

Traders are creatures of habit, and, at least in the short term, patterns have an uncanny habit of repeating themselves.  There's a high potential for this happening with IDTI.  Take a look at the two areas I've highlighted in the light orange rectangles.  Do you see any similarities between them?  Both cover roughly the same range in roughly the same amount of time.  Both volume signatures are uncannily similar.  Both end in a long shadow candle, although the 2 December candle is a bit more bullish with a close above the open.  The two patterns certainly do have the same look and feel to them.

In fact, you can even walk back further in the chart to the prior wave and see roughly the same setup.  The difference in that wave is that much of the downward move was covered in a single gap down, and the volume signature was much higher. Despite those subtle differences, we're seeing essentially the same move.

Now let's consider the three waves that have tops on 27 July, 5 October, and 25 November.  What we can clearly see here is a succession of higher highs, accompanied by higher lows (3 August, 13 October, and if it holds, 2 December.)  In fact, when you start with the 52-week low of 2 February, there is a crystal clear up channel formed with three significant touches of the bottom of the channel.

What we are watching for in this setup is a break above the upper congestion line marked in purple.  We expect volume to confirm the size of the candle that creates the break, however we are not expecting high volume on that break.  An upward break would suggest a continuation of the bullish channel, and that would setup a longer-term play to the upside.  Based on the two prior bullish moves, we should anticipate a two step move, not one.  A seven-to-ten day consolidation period at the mid-point of the move has been the norm, so plan for it.  Either decide to ride it out, or take profits and then re-enter when the move resumes.  Either option works.  (A third option is to take partial profits and let the remainder of the position ride it out.)

If this setup materializes, our price target is between 26.61 and 28.13 marking the 76.4% and 100% lengths respectively of the previous wave.  Excellent risk management, however, is needed since the top of the current wave sits right at the 61.8% extension of the previous wave.  That will be a major resistance level and could well be the source of the anticipated consolidation period.

So there you have it.  Two potential plays coming out of the current pattern.  Let's not anticipate one or the other.  Rather, let the market play out and let's ride the setup that materializes.

Happy Trading.

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