Chart Setup and Annotation Methodology

Given the amount of volatility we’ve seen in the market over the past six months, I thought I’d give an overview of how I go about preparing a chart and then reviewing the current setup.  The chart I’m showing: Helmerich & Payne Inc (NYSE: HP) just happened to be one of the charts that popped up on a scan, yesterday.  I don’t have any position in HP at the moment.  Here's the daily chart we will review:

HP Daily Chart

 First, let’s look at the chart setup itself.  I use a daily chart for my primary analysis and only use the weekly chart for support and resistance analysis.  The chart is configured as follows:

•    Candlesticks – I use candlestick analysis very heavily when entering a trade and again to determine if it’s time to exit that trade.
•    Bollinger Band (20,2.0) – This gives me a nice 20-day moving average and also shows consolidation points that often result in a tradable explosive move.
•    50-day Exponential Moving Average.  This is a heavily watched indicator by swing-traders and is a very good bellwether of current trend direction.

The indicators that I use on the chart are as follows:

•    Volume – This is obvious.  Volume is the most important piece of information on a chart besides price itself.

•    I use a 63-day exponential moving average attached to volume.  This tells me whether we have something exceptional happening that may require a closer look.

•    On-Balance Volume – I plot OBV in the same pane as volume.  This is a great indicator that tells us if shares are being accumulated or distributed.  Attached to OBV I plot a 20-day exponential moving average that is used to signal when the trend in volume may be changing.

•    Commodity Channel Index (CCI) – I use a 20-day CCI as a trend indicator.  Readings above 100 indicate a bull trend is in progress and readings below -100 indicate a bear trend.  CCI is a leading indicator and is a powerful signal for trend-following strategies.

•    Relative Strength Index (RSI) – I use a 9-period RSI coupled with a 21-day exponential moving average for measuring momentum and – coupled with the MACD – as an entry indicator.  (Note that I find a 9-period RSI more conducive to early entry in a trend system than the default 14-period.)

•    Moving Average Convergence Divergence (MACD) – I use the MACD(5,34,5) histogram in conjunction with the RSI(9) as my primary entry.  Again, I find the 5,34,5 setting to be much more accurate for short-term trading than the default 12,26,9 setting.  Note that I’m primarily using the histogram, and not crossover signals.

•    Full Stochastic (5,3,3) – I use this as an early warning indicator that a trade entry opportunity may be imminent, and it’s my primary exit “canary in a coalmine” indicator.

•    I also have a 12-period Rate of Change indicator drawn, and I plot the strength of the stock vs the S&P paired with a 20 period EMA of the same.  These two plots show additional information about the relative strength or weakness of the stock, but they are not part of my overall signal strategy.

So now that you know what my charts look like, let’s review the steps taken to annotate the chart before analyzing any setups.

1.    Find the lowest low and the highest high on the chart.  In this case, the low was 31 August 2017 and the high was 9 October 2018.  Draw the Fibonacci levels from the low to the high.  You’ll see them on my chart in grey.

2.    Now find the highest high and lowest low of the current primary trend for the stock.  In this case, the high was on 9 October 2018 and the low of the current primary trend was on 26 December 2018.  Draw the Fibonacci levels from the low to the high.  You’ll see them on my chart in a light orange.

3.    Next, we need to add the horizontal support and resistance lines.  I use the following schema for drawing these lines.  Dotted thin light blue line is a simple (weak) support or resistance line.  Dashed thick light blue is a significant strong support or resistance line.  Dashed thick purple is a significant support or resistance line from the weekly chart.  Don’t forget the weekly support or resistance.  They produce very strong levels on the daily chart.

4.    We should now look for major trendlines.  I use a dashed green line to indicate an upward support trendline, and I use a dashed red line to indicate a downward resistance trendline.  Be sure to extend them to their extremes.  As you can see in February 2018, once the upward support line was broken, it became a major resistance line for the subsequent consolidation period.  Notice that the current trend is down (red,) although on 26 December we started a countertrend rally that entered a small consolidation phase on 10 January 2019.  That countertrend rally is shown with a green support trendline.

5.    Next, I add the Elliott Waves for the current primary trend.  These are indicated in bold black on my chart.

6.    Once we know where we appear to be in the Elliott Wave cycle, we can determine price targets for the next wave.  I show price targets using a Fibonacci extension plot in green.  Notice, in this case, that the 100% extension is just beyond a major weekly support line.  That’s no coincidence, and with this being the 5th wave in the cycle, that weekly support line would be a likely location for price to consolidate for an extended period.

So now that our chart is annotated, we can then look at the setup and determine what signals will tell us to enter or to walk away from the trade entirely.

1.    We see that we are in Wave 4 – a consolidation wave – of a downtrend.  This tells us we likely have one more downward wave to go before the cycle is complete.

2.    Notice the downward resistance trendline and the upward support line of the countertrend rally.  They are rapidly converging.  A break of the support line and/or a bounce off the resistance line will be a powerful signal.

3.    For an early warning indicator, I’m watching both the CCI(20) and the Fast Stochastic (5,3,3).  What will tell me an entry is imminent is if the CCI(20) drops below 0 and the Fast Stochastic(5,3,3) experiences a bearish crossover within a day or two of each other.  That puts me on alert for an entry signal.

4.    My entry signal -- in this case, for a short position - will be a bearish crossover of the RSI(9) and it’s EMA(21) within one day of the MACD(5,34,5) histogram turning negative.

5.    The entry trigger will be pulled if the signal occurs on a bearish candle, preferably with above average volume.

6.    The stop will be placed above the high of Wave 4, and the (imaginary) price target will be the weekly support line near the 100% price target I drew in step 6 above.  I say “imaginary” because we are not going to actually exit the trade with a pre-defined limit at that level.  Rather, we will exit the trade on a bullish reversal candle coupled with the Fast Stochastic (5,3,3) signaling a bullish reversal.

There you have it!  I hope this provides some insight into how I setup my charts, what indicators I use (and how I use them) and how I go about determining trade setups.

Happy Trading!

IBM - a Once and Future Giant or Is It a Has Been?

For a company founded in 1911, you would think that 2015 would be a bit late for a mid-life crisis.  That, however, is what appears to be happening with IBM (NYSE: IBM) since they no longer appear to know what they want to be when they grow up. That's assuming, of course, that IBM is able to recover from some extremely poor strategic decisions, coupled with an inability to deliver what the market truly requires.

Consider that, since the 1960s, IBM was the computer hardware company, driving the business technology world through the information revolution and into a world where computing technology is a given in our everyday lives.  The phrase, "Nobody ever got fired for buying IBM" was inevitably heard in any management discussion regarding a decision on acquiring new technologies.  Computer hardware and software was IBM's domain, and it was IBM's to lose.  And lose it, they did.

After driving their competition out of business, IBM emerged as the sole provider of Mainframe hardware (including the current z/12 mainframe family and the just-announced z13 mainframe family.)  They are also the sole provider of the mainframe operating systems as well as the only mainframe transaction processors (CICS, IMS, or Websphere for z/OS.)  There's only one problem.  IBM is not increasing their mainframe footprint, and existing mainframe customers are gradually migrating new applications into the non-mainframe space.  The mainframe market is shrinking rapidly, and you can thank IBM's own internal marketing competition for that shrinkage.

IBM managed, though the early part of the 21st century, to undercut and cannibalize their own advantage.  They introduced the P/Series hardware technology as a direct competitor, encouraging mainframe customers to migrate to the faster (at the time) mid-range technologies running their AIX operating system.  The amount of Level 2 cache on the the P/Series boxes was a fraction of what was on the mainframe, though, so multi-tasking was not a forte in the mid-range space.  Websphere Application Server (WAS) is the transaction processor of choice off the mainframe, however it's a major resource hog and can't compete with CICS when it comes to scalability, performance, or stability.  (Ask any WAS specialist how often they hear "A JVM is looping."  Stability and WAS are mutually exclusive.)  Yet, the number of WAS licenses dwarfs the number of CICS licenses, thanks to IBM's efforts to increase P/Series and x86 based sales.

The industry trend now, is to migrate off the mid-range P/Series that IBM sold by the bushels a decade ago.  AIX as an operating system was deemed too expensive and is rapidly losing to Linux as the Unix-based operating system of choice.  Linux can run on all platforms - including the mainframe - and the application code running under Linux is highly portable.  This is where scalability is factoring into the demise of IBM.

Unlike the monopoly IBM was able to develop in the mainframe space, the non-mainframe server space is highly competitive.  HP is emerging as the market leader in that space.  IBM was #2, but in a move that still mystifies me, IBM sold that advantage to Lenovo.  The x86 server space is growing rapidly, and IBM gave it away.  Dell is also in the top 3 in that space, giving customers plenty of options for the lower cost but highly scalable non-mainframe servers.  When you look at the hardware filling all of those expanding data centers, you'll find endless racks of x86 based servers.  Why would a major hardware company even think of abandoning that huge growth market?

In the database space, there are two main competitors and a bunch of also-rans.  You're looking at either Oracle or DB2.  On the mainframe, running under z/OS, DB2 is the only option (although there are still plenty of mainframe shops storing data primarily in VSAM, which comes with the operating system.)  In the non-mainframe space, however, Oracle is a huge factor.  In 2014, the two were neck-and-neck for market share with a very slight edge to IBM's DB2.  Oracle, however, is gaining rapidly.  With some of the acquisitions Oracle - the company, not the database - made over the past few years, they are now a force to be reckoned with in both the hardware and software spaces.

So what are IBM's plans for the future?  Well, we know they've abandoned the chip market and they've abandoned the x86 market.  They are hanging their hat on remaking themselves as a "Cloud Services" provider, a Software company, and, of course, they are touting the just-announced z13.  It's not enough.

To be a viable cloud provider, they should never have abandoned their x86 business.  The competition in that space is huge, and by selling the x86 to Lenovo, they have relinquished a huge cost advantage in that space.  Let an HP or a Dell partner with either Oracle or EMC, and you'll have a stake driven through IBM's cloud-based heart.  IBM's Global Services division - their technology outsourcing business - is hemorrhaging market share to the India based outsourcers.  Let an Infosys, or a Wipro, or a TCS partner with one of those combinations I mention above and IBM's cloud dreams are down for the count.

On the z13 front, IBM mentioned all of the major buzz-words that make senior executives salivate.  They mentioned "Cloud" and "Mobile" in the same breath, and that always makes the non-technical executives swoon.  Under the covers, though, you merely have the next release in their standard mainframe offering with some improved performance, improved throughput in their FICON channels and their zIIP specialty engines.  They've made some nice improvements in the zBX blade-bolt on to the mainframe.  But, at the end of the day, it's still a mainframe, and you're not going to see anyone flock to the z13 to satisfy a cloud or mobile requirement.  For existing mainframe customers, it may delay a migration to the distributed world, but it's not likely to attract new mainframe customers, and as companies world-wide continue to squeeze their expense budgets, new customers is precisely what IBM requires.  They're not able to squeeze more revenue from their existing customer base. 

The direction IBM is taking at the moment does not lead me to believe they are on the right course.  Rather, I see them heading in the exact opposite direction from where they need to go.  For now, the only thing IBM has going for it is its name.  Of course, there was a time when one might have said the same for Sperry Rand.