MSI Showing Weakness On 52-Week High

Motorola Solutions, Inc. (NYSE: MSI) reached a 52-week high in trading on Thursday, 8 December 2016.  The pattern leading to the high coupled with the reversal on Friday, however, signals potential short-term weakness that may well be tradeable.

MSI Daily Chart

The candle drawn on Thursday's high was a doji, and it did so on extremely weak volume.  A doji of this shape - only a two cent difference between open and close, with a long tail and short wick - is, in and of itself, and extremely unreliable signal.  The pattern represents indecision.  It's a day where neither the bulls nor the bears were able to take control.  The long lower shadow tells us that there was an attempt by the bears to take the market lower, however that was beaten back and the stock closed essentially right where it opened.  The extremely low volume also tells us there was very little interest in the stock, either way.  There was neither demand nor supply, indicating that the smart money was sitting in "wait and see" mode.

The next day - Friday - drew a long bearish candle.  We now have a multi-day pattern to analyze.  The short uptrend from last week ended with a strong bullish candle on Wednesday.  Thursday's doji gapped up at the open and left a long shadow.  Friday resulted in a long bearish candle that retraced most of Wednesdays white candle.  That pattern is known as an Evening Star Doji and is one of the stronger short-term bearish reversal patterns we follow.  The key, here, is short-term. 

Let's now turn our attention away from the candle pattern and see what other information we can glean from the chart.

First, let's look at the RSI(9) oscillator.  The peak of this oscillator in the short-term pattern we're studying occurred, not on a high, but on a strong bullish candle the day before a high on 15 November.  The next day traced what was then a 52-week high, but the RSI retreated slightly.  Our most recent 52-week high this past Thursday drew an even lower RSI peak.  What we're seeing is a bearish divergence in the RSI.  The stock has traced higher highs but the RSI has traced lower highs.  It's a signal of impending short-term weakness.

Next, notice the upper green dashed line.  This was drawn from a high on 6 September through the high on 16 November.  Notice that it also formed resistance in the 3-day Evening Star Doji pattern that ended trading this week.  We now have two forms of resistance that are impeding upward progress - this upward diagonal resistance line and the 52-week high horizontal resistance line.

Let's now consider what volume is telling us.  I always include two moving averages on volume: A 200-day simple moving average line that is very smooth, and sets a baseline for long-term volume patterns, and a 50-day exponential moving average that gives us a measure of how volume has behaved in the last quarter.

The stock's rise started on 4 November 2016, and did so on volume significantly above the 200-day moving average.  That was a confirmed bullish move.  Volume, however, has been average at best since then, and only once touched that 200-day average in the current upward move.  The 52-week high and the day following that high were well below even the 50-day average.  Interest in moving this stock has waned.  Volume is currently not confirming any move, which is a major caution sign for continued upward movement.  There must be demand in order to move a stock higher.  Conversely, stocks can decline - and decline rapidly - on either high supply or lack of demand.  What we're seeing at the moment may be an indication that demand has, at least for the moment, dried up.

So where does that leave us?  Well, for the moment, this is not a stock that I would play to the upside.  Not, at least, until we see some signal that demand has re-materialized and the Evening Star Doji is violated.  Notice the short-term Fibonacci Retracement drawn from the 2 December low to the 52-week high.  (The numbers are to the left of the pattern.)  A violation of the 23.8% retracement level would be a short entry I'll consider.  A price target range in such an entry is highlighted in green, ranging from the 76.4% to 100% retracement levels of the pattern.  A protective stop would be just above the high of Friday's candle.

There are several areas between entry and target that could require a quick exit.  As in most patterns, the 50% and 61.8% retracement levels can form support.  Any pause at those levels would require an exit.  There is also that diagonal dashed red support to consider.  That line proved to be major support during the prior short-term pullback, so we need to be aware of it as our trade develops.

Notice, too, that before we get to our price target region, we must also traverse the 10-day and 20-day moving averages.  Now, a reversion to the mean theory would favor a return to at least the 20-day.  Be aware, though, that either of them could provide support, causing a decline to stall at that level.  Again, if the trade weakens, then it's time to exit.

The final major point of concern is at 14:00 EST on Wednesday, 14 December.  The US Federal Open Markets Committee (FOMC) is widely expected to announce an increase of 0.25 points to short-term Fed interest rates.  That increase is already factored into the market, however that announcement will also include forward guidance and a general assessment of the US and world economy.  Predicting how the market as a whole, never mind individual stocks, will react to a FOMC announcement is a task best left to players of Three Card Monte.  Personally, I plan on extreme volatility on the afternoon of the announcement, and I assess the status of any open positions heading into the 14:00 announcement to determine if I'll close them or ride either the wave or the rip tide.  More often than not, I'll close the position.  I can always reopen it if conditions warrant after the announcement.

Bear in mind that the current signal is a short-term trade.  If it manifests, we expect to be out of the trade in one to three days.  The overall stock does not suggest long-term weakness, and neither does the overall market.  Plan your position sizing and your risk management strategy accordingly.

Happy Trading.

What To Watch As IDTI Lines Up For Next Move

As I've mentioned previously, one of my favorite setups is a long lower shadow (preferably a hammer) following a down trend, or a long upper shadow (preferably an inverted hammer) following an up trend.  When found at the potential top or bottom of a trend, both of those candles signal a potential trend reversal if they are accompanied by high volume.  When volume does not confirm the pattern, however, a much deeper analysis may be needed to determine what is truly happening with the stock.

Integrated Device Technology, Inc. (Nasdaq: IDTI) appeared on my scans this morning, and it prevents a fascinating study with multiple options setting up over the next week.  We'll add this stock to the watch list and keep an eye on it since the setup for the next move has only started to develop.  Let's take a look at the daily chart to see what it can tell us.

IDTI Daily Chart

We can immediately see that, following a major gap down on 2 February 2016, the stock traded sideways for the remainder of the year.  The gap was closed several times however no upward breakout was sustainable.  The major pivot point, interestingly enough, is the 50% retracement from the pattern established with the 3 December 2015 high and the 11 February 2016 low.  Thus far, attempts to push above that 50% retracement have been brief and unsustainable.  Thus far.

With that in mind, let's look at the two major setups that we see, one forecasting a move to the downside and the other a move to the upside.

Setup One - Flag Development with Downside Break.

Could we possibly ask for a better flagpole setup than we have starting with the high of 25 November to the low of 2 December?  The low ended with a long-shadow candle, but on lower than average volume.  It wasn't quite a hammer - the wick is a bit too long for me to call it a hammer - but the implications of the long shadow remain the same. 

Remember that pivot point at the 50% retracement?  Well, that's precisely where we sit right now.  Two consecutive long down candles on high volume pushed us back below that 50% level, but unlike the three prior tests of that major support/resistance line, we've immediately retested it with a bullish candle pattern with a long shadow.  That long shadow indicates demand coming into play at the low.

Another major significant pattern to note is that the 2 December retest starts at the bottom of a significant congestion range that ran from 1 November to 11 November.  The bottom of that range was formed with a gap up on 1 November, and it has thus far proven to be a significant line of support.

What we are watching for now is the strength of signals over the next week.  There is a very good possibility that we will trade in another tight horizontal consolidation range bounded by the two thick purple lines drawn on the chart.  Coupled with the flagpole that ended on 2 December, that would create a classic bearish flag pattern.  Given the height of the pole, I'd really like to see at least 4 bars in the flag, and no more than 7 for it to remain a valid pattern.

A downward break following a 4 to 7 day consolidation would set a price target of between 18.69 (the 76.4% extension of the flag pole) and 17.59 (the 100% extension of the flag pole.)  Notice that the 18.69 target sits right smack on top of a support line also created by a brief consolidation period from 3 to 12 August.  If we do break to the downside, that's the likely destination for price.

Watch for this pattern to develop, however it's important not to jump the gun on a trade to the short side.  For this setup to be valid, we need to see that 4 to 7 day congestion period for the flag followed by the break to the downside on high volume.  Don't ignore the volume.  We need it for confirmation of the break to differentiate between a legitimate move and a potential bear trap.

Setup Two - Mirrored Pattern Development with Upside Break.

Traders are creatures of habit, and, at least in the short term, patterns have an uncanny habit of repeating themselves.  There's a high potential for this happening with IDTI.  Take a look at the two areas I've highlighted in the light orange rectangles.  Do you see any similarities between them?  Both cover roughly the same range in roughly the same amount of time.  Both volume signatures are uncannily similar.  Both end in a long shadow candle, although the 2 December candle is a bit more bullish with a close above the open.  The two patterns certainly do have the same look and feel to them.

In fact, you can even walk back further in the chart to the prior wave and see roughly the same setup.  The difference in that wave is that much of the downward move was covered in a single gap down, and the volume signature was much higher. Despite those subtle differences, we're seeing essentially the same move.

Now let's consider the three waves that have tops on 27 July, 5 October, and 25 November.  What we can clearly see here is a succession of higher highs, accompanied by higher lows (3 August, 13 October, and if it holds, 2 December.)  In fact, when you start with the 52-week low of 2 February, there is a crystal clear up channel formed with three significant touches of the bottom of the channel.

What we are watching for in this setup is a break above the upper congestion line marked in purple.  We expect volume to confirm the size of the candle that creates the break, however we are not expecting high volume on that break.  An upward break would suggest a continuation of the bullish channel, and that would setup a longer-term play to the upside.  Based on the two prior bullish moves, we should anticipate a two step move, not one.  A seven-to-ten day consolidation period at the mid-point of the move has been the norm, so plan for it.  Either decide to ride it out, or take profits and then re-enter when the move resumes.  Either option works.  (A third option is to take partial profits and let the remainder of the position ride it out.)

If this setup materializes, our price target is between 26.61 and 28.13 marking the 76.4% and 100% lengths respectively of the previous wave.  Excellent risk management, however, is needed since the top of the current wave sits right at the 61.8% extension of the previous wave.  That will be a major resistance level and could well be the source of the anticipated consolidation period.

So there you have it.  Two potential plays coming out of the current pattern.  Let's not anticipate one or the other.  Rather, let the market play out and let's ride the setup that materializes.

Happy Trading.

MOS Breaks Upward Out of Descending Triangle But Warning Signs Abound

We started tracking Mosaic Co. (NYSE:MOS) for a potential breakout on June 19th.  The stock finally pierced the pattern with an upward breakout yesterday (7/13) that continued with strength today.  You'll note from the chart that there were two other false starts (also upward) on June 7th and again on June 23rd.  Neither of them were a valid signal, however, since both immediately fell back into the pattern the following day.  Yesterday was the third penetration of the trend-line and, since there was strong follow-through today, this appears to be the valid break-out.

MOS Breaks Upward From Descending Triangle

Despite having followed this pattern for close to a month, I'm going to sit this one out.  There are some warning signs on the chart that suggest that there's possibly very little room to the upside.  Here's why:

• The standard "measure rule" in a descending triangle offers a profit target of the height of the triangle measured from the breakout point.  That would give us a target of $33.38 with a stop at $24.39 (just below the bottom of the pattern.)  Our entry would be $28.68, just above today's high.  Now, an aggressive trader could place a stop around $26.99, which lowers the risk, but when I count 6 unique touches of that bottom trend-line, I'd be concerned that a pullback would easily take out that aggressive stop. 
• That brings us to the reward vs risk ratio.  The conservative stop only gives us a ratio of 1.08:1. The aggressive stop is much better with a ratio of 2.76:1, however as I said, I'm very concerned about the probability of that stop being taken out prematurely.  The 1.08:1 ratio is a non-starter.  The number of winning trades needed at that level are much higher than even a professional trader can consistently achieve.
• The profit target assumes we hit 100% of the estimate.  That only occurs about 60% of the time, however, for a descending triangle breakout.  A more realistic target would be $31.17 which is the 61.8% Fibonacci extension of the height of the triangle.  That brings our ratio down to 0.57:1.  There's also a weak resistance line at that level based on the high of the triangle.  That increases the probability that we'd never hit the 100% estimate.
• Today's candle forms a double-top with an almost identical candle that formed June 23rd.  In both cases, the price stalled at the 23.6% Fibonacci extension.  A double top is a bearish pattern that, in this case, has a price target of $20.53.  That, coincidentally enough, meets the 61.8% Fibonacci extension of a downward breakout from the triangle.
• The real killer for this trade, however, is an extremely strong resistance line at $26.91.  That coincides with the 38.2% extension, and it's formed by a low on October 2, 2015, passes through the highs of the triangle pattern, and halted an advance on April 21, 2016 as well as June 7, 2016.  It's a very strong area of resistance and, in all likelihood, the current breakout will stall at that level.

We'll keep MOS on our watch list, despite the fact that we're not taking the trade that setup yesterday.  The reason is that, if it does reverse and fall back into the pattern, there's a much higher probability that it will penetrate the support line at the base of the triangle and then resume the down-trend that has plagued this stock in stages since early 2011.

The other potential short that we will watch for is a break back into the pattern.  At that point, if the market is similarly retracing, we can enter short and ride it at least to the bottom of the pattern, if not beyond.  The way the overall stock market is surging this week, however, we'd only enter that play if the market itself pulls back and begins a downward retrace.

Remember, always stalk your trade.  We're under no pressure to enter a position ahead of its time, and when we do commit capital we always want to do so when the odds are stacked in our favor.  The moment those odds turn against us, the smart play is to revert to cash.  When it comes to MOS, that's precisely what we will do.  Cash is a position, and in this case, we believe it's the right one.

Enbridge Energy (EEP) In Ascending Triangle Pattern

Enbridge Energy Partners (NYSE: EEP) is deep into a classic Ascending Triangle chart pattern.  The company reported mixed earnings on Wednesday, missing analyst earnings estimates by a penny, but beating analyst revenue estimates by $320 Million.  What moved the stock, though, was some very positive forward guidance.  They expect adjusted operating income to increase by 12% over 2014, and they expect their distributable cash flow to increase by 15%.  EEP's stock gained 1.5% in Thursday's trading, bouncing off the triangle's support line on very high volume.  With only 45% institutional ownership and with a 5.9% dividend yield, the stock does have some room to run.

For today's discussion, though, let's take a look at the stock pattern itself - an Ascending Triangle.  There are several very popular stock patterns that are watched by chartists, and this is one of the more reliable patterns that can be very profitable.

The ascending triangle stock pattern is considered a continuation pattern.  So in an uptrend, as EEP has been in for the past year, the pattern is considered bullish.  What forms the pattern is a very strong area of resistance - the top horizontal line on this chart - and a support line that has a distinct upward slope - the bottom line on this chart.

For a pattern like this, we want to see at least three touches of each trend line, and in this case, we have five of each.  Remember, a chart pattern is intended to give us insight into the behavior of traders.  The five touches of the resistance line indicate points where buying pressure has been exhausted, whereas the five touches on the support line indicate the points where selling pressure is exhausted and buyers are again interested in picking up the stock.  The entry point for that buying pressure continues to increase, hence the ascending pattern.

There are two ways to play a bullish entry on an ascending triangle.  For very aggressive traders, you can enter a long position when price bounces off the support line.  This gives the greatest profit potential, but it's also carries much higher risk since there's a well-defined price ceiling in the pattern.  An entry point for more conservative traders is to wait until price closes above the resistance line, providing an entry following the breakout.

According to Thomas Bulkowski, the well-regarded guru of stock pattern analysis, breakout is upward 70% of the time on a bullish pattern, and of those that do breakout, 75% of them reach their price targets.  That's not a bad average at all!  Be aware, though, that there is a pullback to just below the resistance line 57% of the time.  That, in fact, provides a third entry possibility since, if you miss the initial breakout, 57% of the time you'll have another chance to get in when the price breaks resistance a second time.

Setting a price target for this type of pattern is relatively straightforward.  Subtract the lowest valley in the pattern from the resistance line, and - for a conservative target - multiply that by 75%.  Add the result to the resistance line and you have the price target.  So using EEP as the example, it would be (40.50-35.00)*0.75 = 4.12.  Add that to the resistance line: 40.50 + 4.12 for a price target of 44.62.

For added confidence, we'd really like to see the breakout occur on high volume.  Now, the very high volume we saw yesterday was an excellent sign, but remember, that volume was driven primarily by EEP's earnings announcement.  I'd like to see volume above its 20-day moving average on the day of the breakout above resistance, as well.  Assuming, of course, this is one of the 70% that break upward.

As always, when discussing technical analysis, it's important to remember that the charts are telling us something about the behavior of traders.  This analysis alone does not replace the due diligence we still should do before entering a position.

The Slow Stochastic and the Dow Industrials

One of the technical indicators that I really like to use when charting stocks is the 14-period Slow Stochastic, developed by George Lane in the 1950s.  The concept behind this indicator is the theory that prices tend to close near their period highs during an upward trending market, and conversely, they tend to close near their lows during a downward trending market.  The Slow Stochastic will oscillate between 0 and 100.  Generally, chartists consider a security to be oversold - potentially giving buy indications - when the value is below 20, and they consider it overbought - potentially giving sell indications - when the value is above 80. 

The indicator provides two values, and thus two lines, on the chart.  The first line, the %K line, charts the closing price of a security as a percentage of its relationship to the high and low of (in my case) the 14-day period of he stock.  The second line, the %D line, is a 3-day Simple Moving Average of the %K line.  There are several ways to interpret the Slow Stochastic, and I tend to use all of them in conjunction with several other indicators and chart patterns.

Please note!  The indicators (like the Slow Stochastic) do not drive stock price.  They are merely tools by which we are able to understand the actions of traders, and therefore assess if those traders are pumping money into a stock or taking money out of a stock.  The indicators tell us something about the sentiment of the traders, not the health of a company.  In using these indicators, we attempt to determine if - based on trader activity - a price is likely to rise or fall over a given time period.  Indicators are a starting point, but not an end in themselves, and no indicator's buy or sell signals alone will replace the due diligence needed on the overall fundamentals of the security you are seeking to trade.

Here are the signals we can interpret from the Slow Stochastic indicator:

%K / %D Crossovers

Visually, these will jump out at you with a quick glance at the chart.  When %K crosses above %D it's a bullish signal, and conversely, when %D crosses above %K it's bearish.  Like most oscillators, though, you can't rely on just this one signal for buy and sell orders.

%K Crosses above 20 or below 80

This is one of my favorite signals since it has a higher tendency to produce winning trades.  When the %K line crosses from below 20 to above 20, it generates a buy signal.  When it crosses from above 80 to below 80, it generates a sell signal.  Now, be careful here.  As a general rule, I will only take signals in the direction of the prevailing trend, and for that I like to use the slope of the 50-day closing price's Moving Average.  If that slope is increasing, I only take buy signals.  If it is decreasing, I only take sell signals.  Note:  Many traders don't wait for %K to cross back above 20 or below 80.  I do, because I've found that it increases the chances of success despite getting you into the trade one or two periods later.

%K Divergence

This doesn't generate buy or sell signals, per se, but it's a very good early warning signal that a trend may be reversing.  A bullish divergence would be indicated if prices for the security are reaching lower lows, but the %K line is reaching higher highs.  It's an indication that price action is about to reverse and warns us to be alert for a good buy signal.  On the other hand, a bearish divergence would be indicated if price is achieving higher highs, yet the %K line is dropping to lower lows.  It's a warning that a bullish trend may be exhausted and a decline in price is imminent.  In this case, we watch for a good sell signal to either close a position or to open a short position.

So what does all this have to do with the Dow Industrials? Well, let's take a look at both the daily and the weekly charts for the Dow.

Dow Industrials Daily Chart

Look at the time period starting around October 27th.  Closing prices for the Dow were on a very steady upward slope.  The Slow Stochastic, however, was on a downward slope in overbought - above 80 - territory.  The warning signs should be blaring since that's a classic bearish divergence.  Sure enough, the second week of December, the market took a nose dive.  Did you notice that, just before it dove, we had a bearish %K/%D crossover?  You can see the red line - %D - crossing above %K just as the price started to plummet.  That's warning sign number 2.  The final warning came when %K crossed below 80 and, well, you can see what the price action did after that.

So where are we are right now?  The Slow Stochastic is solidly in overbought territory.  %K is above %D and still trending up, but since this is a bound indicator, we know that can't continue much longer.  We don't have any divergence yet, though, so other than being in overbought territory there's nothing else in the Stochastic that would have us concerned.  (A glance at the actual chart also looks pretty good, although we're trading in the upper 20% of the Bollinger Band which is where I start looking for sell indicators.)

But now let's take a look at the Weekly Chart:

Dow Industrials Weekly Chart

As I've noted in the past, the Dow's been trading in a very nice upward channel, bound by the blue resistance line you see on the chart and the 50-period moving average (in red) as support. Let's look at the Slow Stochastic using the 14-period indicator.  The recent down weeks in the market pulled the indicator out of overbought territory and you can see the subsequent (temporary) drop in price.  (Remember, the slope of the 50-period moving average is up, so I'd ignore any sell signals here.  Tighten stops, or wait for a good long entry, but there's no way I'd go short on any security showing that strong an upward slope.)  The Dow bounced very nicely off support again, and we have a very nice bullish crossover following the close at the end of this week.  Looking at the lows of the Stochastic, they are forming a nice upward trend line as well, matching the price action of the lows, so there's no divergence, either.

The only warning signs on this chart, in fact, is that we are approaching the resistance line once again, and we're trading in the upper 10% of the Bollinger Band.  Whether or not we bounce off resistance and head back down or whether we break through resistance and surge upward will depend on the geopolitical situation as well as the economic indicators released in the coming weeks.  Earnings season is essentially over until late March and April, so we won't have earnings announcements pushing the market for the next couple of months.

One last item to note, though, is about the use of any indicator to analyze a market index.  Remember that the index - in this case the Dow - is based on the price action of the stocks that comprise that index.  In today's age of computerized trading, however, the technical analysis of the index itself is used by traders to gauge whether or not they should take some profits in the stocks that comprise the index or whether or not to enter new positions within that index.  Never forget that it's the price action of the underlying securities that drives the index - and thus drive the indicators that we use to analyze that index. 

Market Volatility Is No Cause for Panic

"Volatility" has been the daily buzzword in the market for at least the last six weeks.  Certainly we've seen some wild and wooly daily swings, as traders on both sides of the pond react to seemingly random bits of news.  If we take a step back to look at the Dow Industrial's weekly chart, though, we can plainly see that there's no real panic in the market, nor is there any real sense of troubled times ahead for 2015.  Take a look at this chart:

Dow Industrial Average Weekly Chart

A few things should pop right out as us:

1. The Dow is trading well above its 250-period moving average (Green line).
2. The Dow is trading above its 50-period exponential moving average (Red line.)
3. The slope of both the 50-period and the 250 period averages is at a consistent upward (bullish) angle.
4. The 50-period line has been acting as support since late 2011.
5. Resistance - the green line - is proceeding upward at a very healthy slope and - since January 2014 - has been running parallel to the 50-period line.
6. Volume has been relatively stable since late 2013 and is not showing any of the wild increases that would signal a trend change.
7. We're trading at a support level right now (top dashed blue line) and there is a very strong support level around 16,500, coinciding with a 23.6% Fibonacci retracement line.
8. The weekly chart is still experiencing higher highs and higher lows.  That is the textbook definition of an uptrend.

Will there be more downward movement in the next week or so?  Sure.  There are plenty of global pressures out there pushing us downward, and I expect us to at least test the 50-period average around 16,900.  That point, however will be a fantastic buying opportunity. If the resistance trend line continues, the next test of that resistance may be above 18,500.

Now, there's certainly plenty of headwind in the global market.

• Greece is in a staring contest with the ECB and with Germany over what to do with their debt.
• Russia's economy is in meltdown.
• Europe's economy has slowed to a point hovering just above a recession.
• China's GDP, while still a very healthy 6.7%, has slowed considerably.
• The Middle East, Africa, and Latin America are all stalled.
• The US Dollar continues to strengthen against other key currencies.
• A labor dispute at the ports on the US west coast is hampering imports that should otherwise be soaring.
• The collapse of oil prices is starting to put pressure on numerous industries, threatening the growth in the otherwise healthy US economy.

Despite all that headwind, where else would investors put their money?  The US Treasury is always a safe haven, but with interest rates still near zero and not likely to increase until late 3Q15 there's no real profit to be made there.  The European treasuries aren't paying anything either.  Russia's bonds are paying double digits right now, but it's anyone's guess if you'll ever see your investment again.  European stocks are in turmoil as is the Japanese market. Where else will that money go?  As global conditions worsen, expect the US equities market to become the safe haven. 

Take advantage of these downturns in the Dow, the S&P, and the Nasdaq.  They represent the best buying opportunities we've had in a while.  Don't fear this growing volatility; embrace it.  Every dip in prices in the coming weeks is your opportunity to enter this still healthy and still growing bull market without paying too high a premium.  This bull has not yet run its course, nor do I expect it to end in 2015.