Monday, January 02, 2017

Dunkin' Brands Ready For Wave-B Below 52-Week High

The resurgence of Dunkin' Brands (NASDAQ: DNKN) as a potential acquisition target pushed the stock to a 52-week high on 16 December.  The high was a hair below it's all-time high set in mid-July 2015.  The merger chatter is not lighting up the news, however, and it's not the first time Dunkin' Brands entered the merger rumor mill.  Some estimates for a hypothetical merger offer put the price in the $65 to $75 range, well above the 52-week high of $55.44.  The surge on rumor was short-lived, however, and DNKN retreated over the following week to close 2016 at $52.44.

DNKN Daily Chart
Using all of 2016 as a canvas, DNKN drew a complete 5-wave impulse pattern that completed on 16 December 2016 following the latest merger rumor.  From there, the stock retraced 38.2% of the Wave-5 move in classic Wave-A action.  This retracement level is one of the primary points at which Wave-A will typically end, and it's significant that it coincides with the top of Wave 3.  Of course, the 50% level and the 61.8% level also loom as prime targets, depending on just how deep this correction goes. 

The RSI(9) Oscillator does hint at significant weakness in the short to medium term.  The bearish divergence coming off the highs leading to the 16 December peak is pronounced, and the divergence in the lows adds strength to the downward signal.  We can infer from this that either Wave A or Wave C (or both) may be deep corrections.

The buying climax on 16 December, as evidenced by the huge volume spike, adds further confirmation when we factor in the lack of follow-through after that one day spike.  We don't have evidence of demand forcing the stock up at this point.

The two long-term trend-lines that formed at the origin of the entire impulse (offering a long-term support line) and the Wave-2 and 3 progressions (offering a long-term resistance line) appear significant.  Notice that the lines are diverging.  The bottom of this correction could be deep indeed, provided no actual merger announcement intervenes and scrubs the entire pattern.

Let's take a quick look at the Weekly Chart for additional guidance.

DNKN Weekly Chart
From the weekly, it appears that the all-time high in July 2015 was the top of a 5-wave impulse that started back to 2011.  If that's the case, then our 16 December high was likely a Wave-B high on a higher order, and we're now into Wave-C in a flat correction on the weekly chart.  That implies about a 6-month downward move that will probably manifest as a five-wave impulse itself.  (Again, this assumes an actual merger doesn't intervene.)

Notice the long diagonal pivot line drawn from the lows on the chart. That line offered support on each of the pullbacks through the impulse wave, and it offered resistance consistently through the Wave-B move.  That it was breached the last week of the year coming off that high is significant and we can expect it to once again resume its resistance role should we attempt to retest to the upside.

Notice the RSI(9) oscillator.  Since the Wave 3 top in March 2014, the RSI was unable to penetrate the 70 mark, although Wave-A brought it below 30 twice.  The RSI shows a very strong resistance level at 70, and although it's an ascending triangle in the oscillator, the indications of weakness are significant.

So where does this leave us?  Well, on the daily, we expect the first A-B-C correction to make it down as far as that upward sloping support line.  That it appears to be a flat correction on the Weekly implies that the daily may well be a complex correction and it will ultimately breach that support line.

What we are watching in the short term is the A-B-C pattern in flight now.  A strong reversal candle may signal the start of B, and if possible, we'd like to catch that wave to the long side. We're not going short on DNKN until we see evidence that Wave-B is complete.  Rather, we're looking for a long play on a strong reversal at either the 38.2% line (where we are now,) the 50% line, or the 61.8% line. 

With the long-term correction suggesting a return to test the $37 range, we believe there will be several viable swing trades to play with DNKN before it ends.  Because of the merger rumors, we have to exercise care in our short plays, and we'll adjust position sides accordingly.  For now, however, we'll put that rumor to the side, at least until there's evidence that it's closer to becoming a reality.  Watch for the reversal signals, and play each of the waves as they manifest.  Remember, where Wave-B ends will tell us what type of a corrective pattern Wave-C will display, so watch it carefully.  In the meantime, let's try to catch Wave-B when it starts.

Happy Trading.

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