Monday, January 30, 2017

Zig-Zag Correction in AEP Sets Up Long for Wave-c of B

On a day when the Dow Jones Industrial Average (INDEX: DJIA) retreated 122 points to close back below the 20,000 milestone, American Electric Power Company (NYSE: AEP) registered a .38% gain and pushed to the top of a two-month long horizontal channel, while setting up for a potential upside breakout.

The monthly chart shows a stock that started its current 5-wave impulse pattern at the end of the financial crisis in 2009.  Wave-I completed in July, 2016 and the stock is currently running its course in a Wave-II corrective pattern.  Note that, while we show Wave-A as complete on the monthly, that is not a conclusion we can truly reach just yet.  The first downward move only covered a 23.6% retrace, so there's a lot more potential to the downside.  We'll need to see how this behaves.

AEP Monthly Chart
The RSI(9) on the monthly chart shows a bearish divergence, and the length of that divergence suggests that this correction could cover a lot of ground.  Note that the MACD does not show a divergence on the monthly, but it has provided very reliable crossover indications at the beginning and end of each wave.  Given the reliability throughout Wave-I, from a monthly perspective we should be able to use it to signal the start of Wave-B.  From the current pattern, it does not look like we've reached the bottom of Wave-A, so there appears to be more weakness in store.

 The weekly chart's wave count tells a slightly different story with respect to Wave-A.

AEP Weekly Chart
Here, we can see the formation through the Wave-I top, and it looks like Wave-A was a valid 5-wave impulse. We also see the reaction off what appears to be the Wave-A bottom with Wave-a, and it looks like Wave-b has gone horizontal.  From the current setup, it appears this overall corrective move will be a Zig-Zag, so the monthly is correct in signalling more weakness towards the downside.  The weekly, however, is telling us we have a bit of room to the upside before that next drop occurs.

As in the monthly, there's a bearish divergence evident in the RSI(9).  The divergence is also evident in the MACD on the weekly, as we compare the heights of the last three highs.  As was the case in the monthly, the weekly crossovers have been reliable signals.  There's a bit of a warning flag in the current MACD, however, in that it could develop into a Zero Line Retrace pattern.  We have to watch the movement of the main line here, since the way it's hooking, it could just brush the zero line and then turn down again.  A crossover at that point would be an extremely bearish signal.

So now let's turn to the daily chart to figure out how we want to trade this stock.

AEP Daily Chart
There's a bit more strength showing on the daily chart than we see on either the weekly or the monthly.  First, that horizontal pattern we've experienced for the last two months came on a break of a strong diagonal resistance line.  When we complete the upward move, we need to watch the behavior as we once again approach that line since it could be a strong support line in the future.

The horizontal channel that formed starting in early December did so bounded by two very strong horizontal support and resistance lines that ran the length of 2016.  The upper line was a major pivot line, flipping from support to resistance and back again several times over the prior year.  Each time, it proved to be a very strong signal line.

What we show on the chart from Wave-A is what looks to be an a-b-c Zig-Zag that will lead to a Wave-B top that corresponds to another major resistance line that has shown staying power in the past.  From there, if it's a true Zig-Zag, we can expect a lengthy downward move in Wave-C, and that would explain the bearish divergences showing on the weekly and monthly.

For each of the significant waves, once again we see that MACD provided a good signal, so we're watching it here for a sign that Wave-b is in flight.  Today, in fact, we did get a signal line crossover (which is what flagged this chart in my scans) and the stock moved to the top of the horizontal channel, poised for a potential breakout play.

The MACD is also showing signs of a potential Zero Line Retrace (ZLR) which, approaching it from the top, would herald another move to the upside.  That's consistent with the short-term expectation of a rise to complete Wave-c of Wave-B.

So that is the move we are currently looking to trade.  On a break of overhead resistance, we will enter long with a protective stop just below the lower support line.  Notice how the height of Wave-a extended from the bottom of Wave-b takes us to the next major overhead resistance line.  There is also a potential resistance line that is not shown, but sits very close to the 76.4% extension.  We'll use that as our conservative price target, since this next move has a high probability of ending between the 76.4% and 100% extensions.  That move will complete Wave-B, and when you look at the length and shape of Wave-A, we believe there will be several swing-trade opportunities in Wave-C as well.  Market conditions at the time will determine which of those waves we attempt to trade.

Happy Trading. 

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