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!

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.