LLY Forms Pennant Above Support After Exhaustion Gap

We last discussed Eli Lilly (NYSE: LLY) on Thanksgiving Day, the day after the stock plunged following some bad news about Solanezumab's trial failures: The Grape's Vine: "Solanezumab Failure has Eli Lilly Down But Not Out"  The upside trades we discussed in that column are playing out as expected, and the stock is once again poised for another entry.

LLY Daily Chart

The gap down that first caught our attention in November now appears to be an exhaustion gap.  At the time, of course, it had the potential to be a breakaway gap, but as you can see from the subsequent price action, that did not manifest.  In fact, price has now broken back above the low of the pattern preceding the gap, so for all intents and purposes, that gap has been closed.

Notice that the pattern that developed after the gap down was more of an ascending triangle than the flag or pennant we discussed, however the consolidation was what we expected.  It finally broke to the upside with confirming volume on 15 December, and the four-day vertical move created a very nice flagpole for the pennant that has since developed.  That pennant is where we sit, today.

The first indication of the potential for an upside break came from the RSI(9) oscillator.  Even on that extreme low following the gap, the RSI formed a bullish divergence that was our clue that the strength lay to the upside.  Notice, too, the diagonal resistance line formed by the two prior lows.  A break above that line as well as a break above the strong horizontal resistance that had developed would be significant.  That's exactly what happened, and the volume at the time shows very strong demand coming off those lows.

The pennant that is now in progress sits at two very important levels.  First, the base of the pennant sits right on top of a very strong support line.  That line extends across much of 2016, and it's important to note that there was a high amount of demand in play when that line was crossed on 16 December.  Second, the mid-point of the pennant is the 38.2% retracement level of the entire 52-week high to low pattern.  That retracement level is typically the first area where it's possible for a stock to retreat, so we do need to watch for that type of a reversal. 

Take note of the diagonal resistance line (in dashed green) extending from the two prior pattern highs.  At the moment, that line looks fairly week, however the longer the pennant takes to develop, the stronger that line may become.  Also be aware that I drew it through the tops of the pattern.  An alternate drawing would have it brush the top of the bodies of those candles, and in that case it lines up almost perfectly with the hypotenuse of the pennant.  That diagonal pennant line my have some teeth to it.

Conventional wisdom states that a bull pennant breaks to the upside, and that's what we show here with our price targets.  I've drawn the Fibonacci extensions for the height of the flagpole, measure up from the mid-point of the pennant. When trading such a pattern, I set a conservative target at the 61.8% extension level, and will tighten my stops significantly when the stock touches that line.  From there, I'll follow the stops up on a daily basis until stopped out.  Notice, in this case, that the 61.8% extension sits just below a major resistance line (in dark dashed blue).  Equally significant, the 61.8% retracement of the entire 52-week high-low pattern sits right between the 76.4% and 100% extensions of the price target.  We are likely to see considerable consolidation in that range, should we indeed break to the upside.

The other point to consider, although it's not drawn on the chart is that, from the 23 November low, the stocks continues to draw a well-defined 5-wave impulse pattern.  Wave-i completed 24 November, wave-ii completed 8 December, Wave-iii completed 19 December, and Wave-iv is in-flight now.  This still leaves Wave-v which, based on the current pattern, would bring us at least to the 50% extension level as a minimum projection.  (Wave-iii is longer than Wave-i, so there's not upward limit to the length of Wave-v.  The typical Wave-v in this setup would travel at least as long as Wave-i, which is the conservative target we set.)

So that's the play we're watching for LLY at the moment.  A close above the pennant will setup a long entry with a protective stop just below the strong horizontal support line.  Our conservative target is 77.54 and from there we'll follow our stops up on a daily basis until stopped out of the trade.

A close below the support line on confirming volume, however, invalidates the pennant setup.  We see much greater risk to the short side given all other indications on the chart, however, so this is not a stock we're looking to trade short at this time.

Happy Trading.

Solanezumab Failure has Eli Lilly Down But Not Out

Disclaimer: This article is not a buy or sell recommendation.  You must do your own analysis and consider your own risk, money management, and trading strategy before placing any trades.

Pharmaceutical giant Eli Lilly and Company (NYSE: LLY) suffered a serious blow, yesterday, with the announcement that their premier Alzheimer's drug Solanezumab failed Phase III testing.  The latest study failed to demonstrate a statistically significant improvement in the slowing of cognitive decline as compared to a placebo.  Shares of LLY plummeted over 11% at the open.  As a result of the study, Eli Lilly is also taking a step back to assess the status and progress of other Alzheimer treatments they currently have in their development pipeline.

The tale-of-the-tape, however, shows some serious potential for traders in all time frames.  Let's examine the weekly, daily, and hourly charts for LLY to see what information we can glean.

LLY Weekly Chart

 Let's start with the weekly chart.  A selling climax in September of 2012 ended the prior consolidation period for this stock and started the bullish impulse wave that continues through today.  The weekly pattern has thus far traced three well-defined Elliott Waves (marked (1), (2), (3) respectively,) and is currently in Wave (4). 

As of yesterday, we've retraced 61.8% of Wave (3).  The alternation rule is satisfied since Wave two was short and relatively flat - only about a 38% retracement of Wave (1).  Given the weekly pattern, we can expect a resumption of the bullish impulse into a Wave (5).  Since Wave (3) is longer than Wave (1), there are no restrictions on the height Wave (5) will travel, although it will typically run between 68.2% and 100% of the length of Wave (1).  If yesterday marked the end of Wave (4) - and to be clear, we do not know that, yet - then we have a minimum price target range of 79.25 to 88.77.  Note the caution sign, however.  There is very heavy resistance around 71.00, so once the uptrend resumes, we can expect a bit of a pause and consolidation at that level.  What this chart does tell us, though, is that there should be another bullish impulse coming, and there's potential for price movement between $15 and $24 to the upside.  Since we're looking at a weekly chart, however, do consider that the time-frame for the full Wave (5) move is approximately 20-months.  Playing all of Wave (5) is not a short-term strategy.

LLY Daily Chart

Now let's turn our attention to the daily chart.  This is the chart we use both to assess potential trades and to plan exit strategies.  The methodology we follow uses three charts - the daily for the overall setup and strategy, the weekly for the long-term trend of the stock or market, and the hourly for the entry strategy.  So what is the weekly telling us?

First, it tells us that the bad news really came as no surprise.  Look at that nice double top pattern that developed in August and October, and look at the swift and steady decline that followed the failure to retest those August highs.  Sure, we had a bounce in November - the entire market had a bounce in November, but the volume on the bounce was very lackluster.  It doesn't come close to the volume we saw in late June when the stock covered essentially the same ground on its way to the August high.  What can we conclude from this?  The smart money had an inclination that bad news was on the horizon and they gradually turned shares over in preparation for it.  Their long-term plan suddenly comes into focus when we look at the hourly chart, but more on that later.

The gap up last week was on better than average volume, but as we saw the next day, it was unsustainable.  A test of that high failed, and the stock meandered downward in a lackluster fashion for the next week.  The behavior and pattern strongly suggests that the stock would close the gap before much longer.

Notice, however, that red line I've drawn on the chart.  Prior to yesterday, we'd have expected that line to represent a very strong support line, and we would have played a long position on a test of that line.  That line represents the 38.2% retrace of the entire Impulse, the 50% retrace of Wave (3), and the 50% retrace of yesterday's gap.  With traders in all time-frames spotting significance at that level, we can expect a period of consolidation and testing as price approaches and attempts to penetrate that line.  Of course, following yesterday's gap, that's no longer a major support line but is now a major resistance line.  Either way, we can play it.

LLY Hourly Chart

Finally, let's look at the hourly chart.  In this case, it not only helps us plan an entry strategy, but it also gives us insight into what the smart money - i.e. large institutions and market makers - are doing.  Remember, the market maker is almost always on the opposite side of the retail trader, but if we want to profit, we need to be following, not opposing, that market maker.

So what did the smart money do, yesterday?  The went bargain hunting and bought a tremendous quantity of LLY throughout the day.  The navy blue line represents yesterday's open.  Now, normally, I ignore volume on an hourly chart, but yesterday's can't be dismissed.  Look at the candle and the volume in that first hour.  There was so much demand at that point that the stock moved over 2 points upward in the first hour.  That trend continued through lunch before the bars narrowed and price settled into a narrow range.

Going into the last hour, the stock had gained almost 4-points from the open.  The last 15-30 minutes of trading normally sees extremely high volatility as day traders close their positions.  You can glean a lot of information in that period.  Wednesday's close was particularly significant since the market is closed today for Thanksgiving and tomorrow has a 1:00 PM close.  Many traders turn it into a 4-day weekend, and volume will be extremely light tomorrow.  As a result, short-term traders - both day traders and swing traders alike - do not like to carry risk through the close on the Wednesday before Thanksgiving.  Too much can happen before the market opens on Monday.

Did we see the smart money unload their shares yesterday afternoon?  Not even close.  Oh, it was slightly down in the last hour, but you'd expect that.  The range, however, was extremely narrow, and the volume was en par with midday.  The smart money not only held onto their shares, but they also kept price in a very narrow range.

So, how are we going to play this stock?  There are numerous potential strategies that could play out: 

1.  A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with a downward breakout.  If that happens, then we'll be looking to play a short when the flag or pennant is violated.  Our price target in that case would be 53.75. (I normally set the target at 76.4% of the height of the flagpole, either adding it to or subtracting it from the violation price depending on direction.)
2. A four to seven day consolidation period could follow yesterday's action, creating either a flag or a pennant with an upward breakout.  If that happens, then we'll play a long position when the flag or pennant is violated.  Our price target would be 78.84, although we would expect that to be a five sub-wave impulse that we'll likely play separately.  
3. Without a flag or pennant pattern developing, we'll look to play a sustained break of yesterday's high with a long position, setting the target at 70.75, just below that major resistance level.  
4. Once price is playing around that resistance level, we will watch for two things.  If there is a second failed test of that resistance level, then we'll play a short back down to yesterday's low.  If, however, a second test succeeds and it's penetrated, then we will wait for the stock to drop back down to that resistance line in a retest.  At that point, we'll look to go long  with a target back to around 76.50.  (Notice the resistance lines forming at that level.)

You'll notice that we're not looking to play a short if yesterday's low is taken out unless that happens following a flag or pennant.  Due to yesterday's decline, there's a 4-day short-sale restriction in effect, so we have plenty of time to assess  any plays to the downside.  Until mid-next week, the only plays are up, and that's just fine for now.  Once that short-sale restriction is lifted, however, be cautious of a downside surge that could produce a price trap.

However you chose to play this, be sure to determine your exit strategy in advance.  One of the primary rules of swing-trading is to know how you will exit the trade before you ever enter the trade.

Happy Thanksgiving!