Bearish Harami and RSI Divergence Urge Caution with AAL

The Bearish Harami candlestick pattern is a two-day pattern that often signals a reversal from an uptrend.  The rules for this pattern are as follows:

1. The stock must be in a clear uptrend.
2. Day one is a long body candle.  It's not required, but the pattern works best if it is a white body candle, not a red.
3. Increased volume should confirm the long body candle.
4. Day two is a short body candle.  The color of the candle is opposite the color of Day one.  (Ideally, this is a red candle.)
5. The body of day two's candle must be completely inside the body of day one's candle.  Either the top or bottom of the day two body may be equal to day one's, however not both.  The second candle must be shorter than the first.

The Bearish Harami pattern is an indication that demand has waned and the stock may be facing an imminent reversal.  Confirmation on the third day occurs when the move continues down, closing below the low of both candles in the Harami pattern.

American Airlines Group (Nasdaq: AAL) completed a classic Bearish Harami pattern today (8 December 2016).  All five of the requirements are present. 

AAL Daily Chart

The two-day Bearish Harami pattern is circled in orange, as is the accompanying volume pattern that confirms the validity of the candlesticks.  What makes this setup even more ominous for AAL is the bearish divergence seen in the RSI(9) oscillator.  In this case, the divergence occurred because the stock was making a higher high (on significant volume) while the RSI was making a lower high.  It's another sign that demand for the stock is waning and a reversal may be imminent. 

Beginning with the 52-week low on 27 June 2016, AAL appears to have completed Wave 3 of the 5-wave Elliott Wave impulse.  Since the next wave is a corrective wave 4, this adds another measure of support to the validity of the Harami.  Since Wave 2 was a flat and long corrective wave, the alternation rule states that Wave 4 will likely be short and steep.  Several possible targets glare out at us from the chart:

• A 23.6% retracement to the 43.50 range is the first obvious point.  There's support at that level, too, extending out to the 21 March 2016 high.   This level coincides with the 38.2% retracement level of Wave 3, so the evidence is lining up nicely to support this retracement level.
• A 38.2% retracement to the 40.00 range is another possible point.  The line of support at that level is much greater and extends across the entire chart.  There's a prior congestion point at that level, and it also leaves us just above the high of Wave 2.  This would be an extremely deep corrective wave, however, and requires breaking through several prior support lines to reach this deep.  This level coincides with the 61.8% retracement level of Wave 3, so it's certainly within the realm of the practical, so let's not discount the possibility.

 The strength of the overall pattern is also confirmed by today's market action.  While AAL was declining 1.23%, the broader market experienced a .33% gain, recording a new all-time high.  Again, it's important to remember that this analysis results in a probable move, not a definite move.  There are a number of factors all signalling a pull-back is imminent in AAL, however, such a pull-back is by no means a certainty. 

Based on our analysis, we will not be looking for a long entry in AAL until Wave 4 completes and we see evidence of a return to the upside.  As strong as the overall market has been, however, we'd prefer to play AAL to the short side in conjunction with a pullback in the broad market.  We'll be looking for weakness in the Dow and NASDAQ futures before the open and will only enter short if the broader market is also in decline after the 9:50 EST time frame.  (Again, we prefer to avoid the volatility associated with the open since our holding period is a few days, not hours.) 

Finally, exercise caution as the stock approaches the diagonal support line marked in green.  Based on the number of touches and the way it held just prior to the Harami, that could turn out to be a significant support level.  Don't dismiss it.

Happy Trading.

PTC In Strong Bull Channel Showing Signs of Distribution

When Parametric Technology Corporation (Nasdaq: PTC) missed earnings by $0.10 per share, and missed revenue estimates by $8.79 million, one would reasonably expect a downturn in stock price, or at least a lengthy consolidation period while the new data were processed and factored into future estimates.  Instead, the response was, "Damn the torpedoes; full speed ahead," albeit on higher volume and increased daily ranges.

PTC Daily Chart

You will often read that technical analysis is more art than science, and nothing illustrates that better than this chart.  You will notice that the charts I post rarely include the more popular indicators such as a MACD histogram, an RSI(14) oscillator, or a Stochastics oscillator.  The reason is simple.  The more I trade, the less I care about technical indicators and the more I care about only two data elements: price and volume.  Aside from the moving averages you see on this chart - which I do reference to help clarify trend - there are only two technical indicators besides the price and volume bars. 

You'll see an orange line representing "On Balance Volume" overlaying the volume histogram.  Again, it's used (in my case) to help identify volume trend.  Is high (or low) volume an indication of accumulation or distribution?  That's all I care about in that case.

You'll also see the bars extending from the left side of the chart.  That's a "Volume by Price" indicator that depicts the amount of support or resistance has thus far occurred at a specific price level.  It helps identify how strong a particular support or resistance line may be.

That's it.  My trading does not rely on technical indicators, it relies on chart analysis and attempting to decipher what the market specialists are doing so we can trade alongside them, and not opposite them.  My experience has been that trading solely on indicators is one of the easiest ways to lose money, and my personal preference is to do just the opposite.

So let's take a look at PTC and try to decipher what's going on.

This stock appeared on my radar today following the hammer candlestick (circled in green) that closed the stock's trading for the week.  That the hammer followed two wide-range down days is significant, so that meant giving this chart a closer look.

At a casual glance, we can see that the stock underwent a major change of character starting October 24th.  Volume started to increase and the stock declined significantly on increasing range.  It bottomed before the close on the 26th, and this is where we have the first major indication that the smart money has an interest in this stock.

PTC released their earnings after the close on the 26th. That entire three-day decline was in anticipation of the earnings announcement, not as a result of it.  As we stated at the start of this article, PTC missed on both earnings and revenue.  The stock, therefore, should continue heading south when the market opens the next day, right? 

Wrong.  In fact, PTC gapped UP at the open by $2.45!  It then soared upward another $1.50 before finally settling back to close at $45.59, representing a 4.7% gain on the day following a bad earnings announcement.  It then continued to gain for two more days before a three-black-crows candle pattern drove it back to the low traced on the 26th.  But look at the volume on those three days as compared to the actual ranges of the bars.  Now look at the volume on the four up days that followed.  Clearly, the volume is contradicting the move down.

So what happened?  Well, we know that this stock started to climb steadily higher following a low on February 8th.  The move has been steady but daily ranges have been narrow, and the large volume days had come with the stock opening and closing in a tight range.  What this means is that there was heavy institutional buying.  Market specialists were accumulating this stock long before the public became interested in it. 

In fact, as the public started to jump on the bandwagon, what do we see? Two consecutive down-gap days, only one on higher volume, in late June as the specialists move price back to a level at which they prefer to accumulate shares. 

So that brings us to the current situation.  What do we believe is happening?  Well, based on the patterns we're seeing unfold, it appears that those same market specialists are preparing to take their profits.  It's been a nice ride, and the stock has almost doubled in price since the accumulation campaign started.  What we see at the end of October is the first of the tests to see how much demand remains, and as we saw November 4 through 10, there was quite a bit.

November 30 and December 1, the next two down days on significant volume, represent the start of the next test.  Those two days occurred without any negative news, so there was no fundamental reason for the decline.  Rather, it's part of the distribution phase test as the market specialists sell their shares to a public that is very impressed by that lengthy bullish channel that dominated 2016.

Notice the hammer candle that formed yesterday.  The range was very narrow, however volume was above average.  Demand still came into the stock on decent volume and notice that it came in right at the 61.8% retracement level of the last upward move.  Notice, too, that it did not penetrate the 50% retracement level.  Are the large institutions done?  Probably not.  They accumulated shares for 8-months, and it's going to take more than a month to distribute them.  More likely, we're in for a period of consolidation before the next move.

Can this pattern be traded?  In the very short term, yes, but it won't be for the faint of heart.  If price breaks the 50% retracement, there's a good probability that it will bounce back up to the overhead resistance line set by the pattern highs.  Odds that it will penetrate that level diminish rapidly, however.  The caution flag here, though, is that this does appear to be a distribution campaign, so the insiders are counting on the public buying, here.  At some point - it could be next week, it could be next month, or it could be next quarter - the distribution campaign will conclude and the market specialists will cease holding the stock at its current levels.  When this stock finally plummets, that rate of decent will be extreme. 

Should you chose to trade this pattern, be sure to watch the volume signatures as compared to the daily candles.  The combination will offer the best clue as to whether another test of the low will be offered or whether the bottom will fall out swiftly. My preference here is to play the short side, not the long.  We'll wait for the stock to approach the top of the channel pattern - adjusting that channel if it switches to a horizontal pattern - and take short positions on short-term reversal candles with confirming volume signatures.  This way, when the rug is finally pulled, we'll be on the right side of the trade, and not holding a long position as the stock dives past our stops.

Chart reading is very much like detective work.  Look for the clues being offered and attempt to glean what the smart money is attempting to do.  It's more work than simply watching for a cross on an oscillator, but it will improve your capital protection and your risk management significantly.  That, after all, is the key to profitability.  Protect your capital and manage your risk. 

Happy Trading.

Baxter International Signals Start of Next Move

One of my favorite swing-trading scans searches for stocks that draw a hammer candle at a major low or an inverted hammer at a major high.  In the context of Japanese Candlestick charting, a hammer is formed when the open and close are both near the top of the trading range for the period.  The low for the day is significantly below both the open and close, and the high for the day is either at the open or close or it's just barely above them.  When you see the hammer on a chart, it truly looks like a good old-fashioned sledge hammer.  The inverted hammer is the opposite.  Just stand that sledge hammer on its head and you have that pattern.

The significance of the two comes when they are at a major low (for the hammer) or a major high (for the inverted hammer.)  In both cases, they signal a high potential for a trend reversal.  In the case of a hammer, you have a stock that has been trending downward.  After the open, the stock plummets even further, but at that point, demand starts to enter the scene and the stock rises to ultimately close near its daily high.  This often happens when the low encounters a major support line, triggering buy stops for bottom feeders waiting to enter the market.  In the case of the inverted hammer, the opposite behavior occurs.  In both cases, confirmation the following period is essential, and for it to be a good signal, the hammer or inverted hammer should occur on high volume.

Baxter International (NYSE: BAX) appeared on my scans last night, tracing a classic hammer pattern on high volume at what appears to be the bottom of an Elliott "C" wave in an A-B-C corrective pattern.

BAX Daily Chart

Here is a chart where the theories of both Elliott and Wyckoff work hand-in hand.  From an Elliott Wave perspective, I show two possible wave counts.  The Fibonacci retracement levels drawn from the count represented in green line up perfectly, in fact, and that's the count that appears to be the more accurate interpretation. 

The most striking characteristic of this chart is the huge volume signature that dominates May, 2016.  From a Wyckoffian perspective, this would indicate a major change in character and would signal the start of the distribution phase in which market insiders begin a lengthy campaign to sell the shares they purchased at wholesale prices during an extended period of accumulation.  The objective of the market insiders at this point is to hold prices in a tight horizontal range while they sell off their shares over time.  This, in fact, is what we see from the chart.  After that climax marked by the top of Elliott Wave 3, we see a somewhat lackluster fifth wave, followed by a very controlled A-B-C flat corrective pattern.  Notice the nice upward push on high volume just after Wave A completed as the market makers needed to push the stock back up to levels where they wanted to sell.

This brings us to our current analysis and yesterday's hammer candle at what may be the end of Wave C.  Notice that the low of the hammer rests on the 38.2% retracement of the entire pattern.  That's a very convenient support level and the volume signature suggests demand came into play at that point, pushing the stock back up fairly close to its open.  As signals go, it would be stronger if the close were above the open, however the lower close does not invalidate the hammer.

What we don't know, at this point, is which way this stock will trade following the completion of Wave C.  There are three possibilities.  The stock could enter a complex correction pattern tracing another A-B-C wave cycle or an X-A-B-C cycle.  In either case, the direction of travel from here is up.  Or, a new Wave 1 pattern in a 5-wave impulse could initiate, driving the stock higher.  Similarly, a new Wave 1 pattern could initiate driving the stock lower.  The hammer suggests that this is the least likely of the scenarios, but again, we need confirmation.  Today's candle will provide tremendous clues as to where this stock is headed.

When looking at the chart, it's hard to miss the curve of that 200-day moving average.  On July 1, 2015, Baxter spun-off Baxalta which resulted in a major distribution to shareholders.  This positive event had a negative impact on some of the technical indicators such as the 200-day MA that still have a look-back to that time period.  In this case, it's best to ignore the 200-day as it's meaningless following that spin-off.

So here's how we plan to play this stock:

• We will monitor the candle patterns for the next couple of days to determine if Wave C has truly ended.  We will also be looking for confirmation that the hammer signal is valid.
• If the hammer is valid and we close above the hammer, we will take a long position.  Our price target will be 48.70, marked by the overhead resistance level shown in a blue dotted line.  If we are into an X, A, or 1 wave, then that is the most likely short-term target.
• If the hammer is invalidated and we subsequently close below the low of the hammer, then we'll stay on the sidelines.  There's a major support line only two points below the low of the hammer, and that does not provide enough reward for a trade to the short side.

This will be an interesting pattern to watch.  There are numerous upside plays here, and overall the company has been performing extremely well.  They've a very long history - several years, in fact - of consistently beating earnings and revenue estimates.  They have a new drug - Prismocitrate 18 - entering Phase 3 Clinical Trials with 160 ICU patients in the US and Canada participating, and they are one of the primary renal care providers in the nation.  All things considered, there is more to the upside than downside with this stock.

Happy Trading.