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.

DHI Signals Short Term Bull Channel Trade

DR Horton, Inc. (NYSE: DHI) approached the lower (20,2) Bollinger Band on very high volume, bouncing off to produce a long-tailed spinning top in today's trading.  The significance of the high volume is somewhat diminished by today's quadruple witching, however the remainder of the chart shows promise for a short-term long play.  Let's first take a look at the daily chart. 

DHI Daily Chart

The price action on 9 November penetrated both the lower Bollinger Band and the 61.8% Fibonacci retracement from the 52-week high to low pattern.  Of significance, however, was the immediate bounce back to the 50% level where a very strong pivot line has already been established.  Since then, we've found support at that 61.8% line on two additional tests. 

Both the highs and the lows in this six-week pattern have created a well-defined bull channel, albeit with a modest slope.  Today's price action marked the third test of that support line, but we'll take a much closer look at that test shortly.

From the daily chart perspective, we're now looking at a potential short term channel play.  The RSI is confirming the short-term bullish signal, so there are no worries there.  The higher highs and higher lows are also encouraging, as is the volume in today's action.  Remember, though, that the volume was influenced by quadruple witching, so we do need to downplay it just a bit.

To get a better feel for today's action, and to analyze a potential entry and protective stop range, we'll turn our attention to the 30-minute chart.  (I prefer 30-minute charts to the 60-minute chart since the open and close volatility fits neatly into one candle on each end and isn't potentially hidden by doubling that cycle.  Also, the trading day is 6.5 hours long, so there's an inconsistent overlap of alternating days using the 60-minute.  I find the analysis works better on the 30.

DHI 30-Minute Chart

Well, the very first thing that pops out as us is the long tail.  That certainly caught our attention on the daily chart, but here we see that it occurred right in the first 1/2 hour of trading.  That has all the hallmarks of some stop gunning.  It's the type pattern you'll see if the specialists are taking out sell stops in preparation for a move upward.  For the rest of the day, the stock traded in a narrow range that created a bull pennant with the long tail acting as the pole.  Volume at the end of the day was high on a very short candle, but given today's options expiration, that's not a surprise.

Notice that, just like the daily chart, the 30-minute chart is also hovering right at the 61.8% retracement level from the 52-period high-low pattern.  There is also a very strong horizontal pivot line (in dotted bold blue) that is now acting as support.

The 30-minute chart is providing a potential entry zone as well as a good protective stop level.  For the entry, remember that we don't enter a position before 10:01 EST.  You can see on this chart how volatile that first 1/2 hour is, and it's the territory primarily of the market specialists, day traders, and scalpers.  I prefer to let the market settle down a bit and enter after we can see the true direction it's taking.  So 10:01 is the earliest I'll enter a position.

The range we'll set for entry, based on this 30-minute chart is from 0.10 above the upper pennant line to 0.10 above the height of the full flagpole.  Above that and the reward to risk ratio is too low, and below it invalidates the signal.

There are three potential stop loss levels depending on how aggressive you are as a trader.  The first obvious level is just below the pennant.  That level is a bit too aggressive for me, however, and I believe it's an area likely to be taken out if there's still some stop-gunning on the horizon. 

The second level is what I've highlighted in red.  That area forms support from the two-day pattern, and that nice rounded bottom heading into Thursdays close appears to be a solid bottom.  In fact, that's likely what prompted the specialists to go stop hunting at the open, today.  Now, that level is still somewhat aggressive, however as long as we avoid the first 30 minutes of trading, we may well avoid another stop-hunt at that level.  So personally, I'll set a stop just below that red line.

The final level, of course, is below the low of that long shadow.  That's the most conservative level in this short-term pattern, and for me it's too conservative.  The distance we'll have to travel to get a decent reward to risk ratio is more than I can comfortably plan.

For our exit strategy, we return again to the daily chart.  Remember, we take our signal from the daily, select our entry and stop from the 30-minute, and then exit based on the daily.  As we can see on the chart, there's a very strong resistance line (in light blue) that coincides with the upper Bollinger Band.  It is also intersected by our bull channel in three trading days.  That's where we'll set our price target. 

This is a pure channel play, so we must be prepared to exit at any sign of weakness.  We also need to be aware of that intermediate pivot line that sits dangerously close to the center of the Bollinger Bands.  There's a risk of pausing or retreating at that level, and we must remain nimble enough to recognize it and exit immediately.  This is a two or three day play, not a long-term play, so we can't afford to sit around and wait for a consolidation to work itself out.  Exit immediately on any weakness.

Happy Trading.

Stalking A Trade: Patience Is a Virtue

Almost two weeks ago, we discussed a bull pennant pattern setup drawn by General Electric (NYSE: GE).  A pennant breakout occurred twice in the last two weeks, however neither of them were solid trade setups.  Let's take a look at the chart as of this morning and review why we are still stalking this trade as opposed to holding on to an open position.

GE Daily Chart

The initial post called attention to the bull pennant following the close above that pennant on 22 November 2016.  Notice the caution flag, though.  I pointed out that the breakout occurred on low volume.  When trading any breakout, it's important to confirm that there's true conviction behind the move.  Flag and Pennant breakouts have been popularized in numerous publications, and as a result, market makers will often take advantage of the pattern by targeting the entry stops that they know will exist in large numbers.  What you see in that case are a lot of traders getting trapped by an entry at the right spot at the wrong time, only to have the stock pull back into the original pattern.

The sign to watch is volume.  A breakout on low volume significantly reduces the probability of a successful trade and is a warning sign that you're falling into either a bull or bear trap depending on the breakout direction.  We see that clearly in the week following 22 November.  A couple of lackluster narrow range days on equally low volume followed, and the stock then dropped back into the bottom of the pattern.

But what about that second breakout on 1 December?  That was a nice, strong move to the upside, and look at the volume!  Sure that confirms the move, right?  Well, not so fast.  There was, indeed, high volume that should be the confirmation we're awaiting, however two warning flags kept us out of this move, as well.  The first warning flag was the rising volume on the two days preceding this breakout.  Both of those were down moves with confirming volume.  Why is supply coming into this stock, now? The second warning flag is that horizontal resistance level at 31.50.  Not only did it form an extremely strong and persistent level of resistance in that tight horizontal move from 5 August to 2 September, but the level held firm again when tested four times between 25 November and 5 December. 

That the resistance level sits close to the 61.8% retracement level of the overall pattern is a bit of a warning sign in and of itself.  That it has held firm now for four months is a major warning sign.  It will take some conviction to break through that barrier, and thus far we haven't seen it.

This is why we stalk a trade and seek multiple confirming signals before committing capital to a position.  As swing traders, we know that we're not going to catch the precise top or precise bottom of a move.  Many novice swing traders attempt to do just that, but in reality, it's the quickest path to draining an account that you can find.  Well, maybe the second quickest.  Not having a solid risk management plan with a well-documented exit strategy for a trade is likely quicker.  Either way, we know we're trading the middle of moves, not the full range.  So, in reality, when you factor in slippage, commissions, and actual entry and exit points, there has not been much profit potential for the retail swing trader between the top of that pennant and that overhead resistance line.  Before we commit capital, we need more confirming data points that a move is genuine.

So what are we waiting for here?  Well, a volume-confirmed break of that resistance line would be good.  From a Wyckoffian cause and effect perspective, that resistance line has build up a significant amount of cause.  The move off that line, therefore, can reasonably be expected to produce significant effect.  In fact, point and figure charts (not shown here) point to potential upside targets in the 34 to 38 range.  The time period for such a move would be well outside our swing-trade time horizon, of course, but you see the point.  A significant amount of cause is being built, and that normally results in a significant effect (i.e. price move.)

The point of all this is that we need to seek multiple confirming signals to increase the probabilities of a successful trade.  Pattern breakouts are but one signal.  Volume patterns are a second.  Support and Resistance Lines are a third.  Fibonacci retracement levels are a fourth.  Any combination of those converging in the next greater or next lower time period (e.g. a weekly or hourly chart if we're trading off the daily) would add a fifth.  The more confirming signals we have, the higher the probability of success.  At a minimum, we would like to see two signals, but if we're going to commit to a full position size, we would prefer to see three or four confirming signals.

Such a conservative strategy means missing some opportunities, of course.  Our objective, however, is not to capture every opportunity.  Rather, our objective is first and foremost to protect our capital.  That means managing risk properly, and only committing that capital when the probabilities strongly favor a successful outcome.  Stalk your trade, and display patience before committing capital to a position.  Leave it to others to fall victim to bear and bull traps by attempting to capture every move out of a widely known and well publicized pattern.  Instead, patiently enter after the weak hands have been shaken out of the market, and ride the wave generated by the market makers taking their own positions to the target profit level.  Trade with the market makers, not against them.

Happy Trading.

NTRS Forms Bullish Pennant On High Volume Flagpole

Northern Trust Corporation (NASDAQ: NTRS), a Chicago based financial services holding company, formed a well-defined pennant after tracing a strong 4-bar flagpole on high volume.

NTRS Daily Chart

In addition to the classic pennant formation, the current uptrend completed three waves and is currently in the fourth.  Note that, for a short term price analysis, we're looking at the last of the impulse patterns starting on July 6th, not the major impulse that started at the low on February 11th.  The longer term wave is certainly a valid one, however the time horizon for the next wave in that analysis is longer than our preferred holding period.  So, for now, we'll focus only on the shorter wave analysis.

Starting with the flagpole, we will use 76.4% of the height of our pole as the measure for our price target.  Using this standard, the target for our pennant in an upward breakout is 88.71.  If, however, the pattern fails and breaks out to the downside, we will use the first major support line at 75.84 as our target.  Remember, at this point we don't know which way this pattern will break, although the volume signature at present is pointing us towards an upside breakout.

Our Elliott Wave analysis also points towards a fifth wave upward breakout with a target of 90.29.  Now, that target would take about two months to play out and would likely be a five sub-wave pattern itself, so while we're using it to confirm the potential strength of an upward breakout, the time horizon is too long for our preferred holding period of under a week.  Rather, we'll stick to the pennant targets since we can anticipate a swift short-term spike towards either of our targets.

Looking at key dates for this stock, we can ignore earnings within our holding period.  They next report on January 18th and we'll be out of any position long before then.  The other key date, however, does impact the analysis, however.  NTRS goes ex-dividend tomorrow (November 30th) with a $0.38 dividend.  For you dividend players, that means you need to own the stock at the close today, and the pay-date for this dividend is January 1, 2017.  It's important to factor in that dividend in our chart analysis, however, since those 38 cents will be taken off the stock price tomorrow at the open.

Here's how we're playing this stock:

• On a break to the upside, we will go long, setting a price target of 88.71.  Our stop will be just below the low of the pattern.
• On a break to the downside, we will go short, setting a price target of 75.84.  Our stop will be just above the high of the pattern.
• In both cases, "a break" indicates a close either above or below the pattern with volume that confirms the move.
• Also in both cases, we will trail our stops seeking first to reduce and then to eliminate risk.

It's important to watch the volume signature on this breakout.  The flag and pennant patterns are extremely popular, and they are therefore prime targets for market makers seeking to take out entry stops, thus trapping the trader on the wrong side of the intended direction for the stock.  We can see that this stock was marked up rapidly on very high volume over a period of four days.  Equally interesting and important, however, are the two down-days in the pennant. Notice the volume on both days.  (Ignore the volume on 11/25 - that was an early close on the day after Thanksgiving, so it tells us virtually nothing.)  The candles across the pennant have been very consistent in range, as has the volume signature.  Price is being held at this level by the market specialists, although it's too early to tell if this is in preparation for another accumulation phase or a setup for distribution.  We need the breakout to tell us that.  Watch the chart, study the volume, and ride on the coattails of the market makers when the breakout occurs.

Happy Trading.

GE Posts Bullish Pennant Break

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.
 
GE showed up on my radar a bit late, so a potential good trade opportunity was missed.  Despite that, it still provides a good lesson in items to watch when analyzing a chart for a short term swing trade.

GE Daily Chart

The trading opportunity came about as GE broke out from a bull pennant pattern on Tuesday.  The flagpole was well defined although the pennant waved in the direction of pole, which is less than desirable.  The breakout occurred Tuesday, and using 76.4% of the height of the flag as our target, we come up with a potential price target of 32.88.  But let's examine the rest of the story.

For openers, we can see that there has been a considerable amount of overlap in trend patterns on this chart going back to the beginning of the year.  By definition, when there's overlap of multiple waves, then we are in a consolidation pattern, not an impulse pattern.  So let's keep that in mind.

We can see that the pattern leading down to the flagpole was a 5-wave pattern. Now, a case could certainly be argued that the two waves prior to that could have been an "A" and "B" wave, which would make the prior wave a "C".  This means we are now in one of three possible waves - an "X", a new "A", or the start of a new impulse wave, making this Wave (1).  For the moment, it's irrelevant since all three of those tend to be 5-subwave patterns.  For the purposes of this analysis, we can treat them equally.

An area of concern on the chart coincides with where our stock is trading right now.  Look at that month-long consolidation period, and look at the strength of the Volume at Price indicator at that level.  We can anticipate a period of consolidation here before the stock decides to either continue its upward climb or retrace back to the start of the flagpole.

Another warning sign comes on the breakout itself.  Volume was extremely light, so there wasn't a lot of enthusiasm for the upward push.  The day after the breakout, there was a very narrow bar, again on light volume.  I'm not seeing a lot of demand driving the price upward.

Thus far, GE has retraced 61.8% of the prior wave, which again forms a natural resistance zone, and there is also horizontal resistance waiting for us at the 76.4% level.  That level corresponds to a failed retest of the prior day's high on April 1, 2016.

Our price target lines up very well with the 52-week high that actually precipitated the stock's decline on July 20th.  That increases our confidence that our target is a good level to either exit the stock completely, or to at least take partial profits and tighten the stops.

So here's how we're watching this stock and potentially playing it.  Today is an early close, and volume will be extremely light.  I won't be entering any position today.  My normal trading window is from about 10:15 to 15:30 Eastern Time.  This avoids the extreme volatility of the open and the close and helps prevent entry at a time where market makers are gunning for stops and limits.  It also allows us to see where the market makers are positioning themselves since we want to be on the same side of the trade as they are.  So with a 13:00 close today, I'm sitting this one out.

I'll be watching that resistance line carefully.  If we see penetration of that line with some gusto, then we'll hop into a long position.  Stops, however, will be extremely tight since I expect at least one more retest of that resistance line before we head north towards the price target. 

A play to watch is for consolidation at the 76.4% level followed by a retest of the resistance line.  If the stock shows a bullish candle pattern on that retest, then that would be the perfect opportunity to jump in, setting a stop just below the low of that resistance pattern.  But we need a bit of patience, since it may take another week or so for that pattern to play out.

The dotted horizontal lines are the Fibonacci Time Zones.  Zone 0-1 marks the time it took for the flagpole to complete.  We're using that as a reference to see just how much enthusiasm there is for an upward thrust, and we're also using it to gauge the width of any subsequent consolidation periods.

There are no earnings announcements on the horizon, nor is a dividend imminent.  We have time to watch this stock play out and to see which pattern ultimately comes into focus.  For now, the play is long, however a failure to break through that resistance line could rapidly change that perspective.  Keep an eye on this one and see which way it breaks.

Happy Trading.