CPI and PMI Releases Show Strength; Paint Complex 2017 Picture

Thursday, 15 December 2016, saw a plethora of significant economic data releases before the markets opened in the US.  These releases came fast on the heels of the FOMC decision to increase interest rates for only the second time in a decade while also signalling a more hawkish monetary policy that may require an accelerated pace of future rate hikes.  Two of the major releases yesterday, the US Manufacturing PMI and the US Consumer Price Index (CPI) lend credence to the inflationary forecasts set forth by Fed Chair Janet Yellen in her Wednesday press conference. 

Manufacturing experienced a strong surge, hitting a 21-month high.  This surge, however, is still well below peaks set in the post-recession era, indicating there may be plenty of room for growth in the months ahead.

Markit US Manufacturing PMI (seasonally adjusted) Source: IHS Market

US manufacturers reported business conditions improving at the fastest rate since March 2015 with manufacturing output expanding for the seventh consecutive month.  The growth in output was attributed to an increase in sales demand, coupled with a need to replenish inventories. 

One major note of caution was signaled in the report, however.  While new work orders received by manufacturers experienced a rapid rise, the report also stated, "This was overwhelmingly attributed to improving domestic demand conditions.  Meanwhile, export sales were close to stagnation, which contrasted with the modest growth seen on average in the second half of 2016."

The stagnation of export sales as cited is most likely the result of the strong US dollar coupled with extremely weak economic conditions in Europe.  Both will likely have a negative impact on the performance of US stocks with heavy overseas exposure.  This will be exacerbated by rising interest rates in the US, further strengthening the dollar against foreign currencies already experiencing downward pressure.

There are strong signs, however, that inflation may increase at a more rapid pace than currently being forecast by the Fed.  An example of this upward price pressure is seen in the PMI report: Input price inflation accelerated for the third time in the past four months during December. Moreover, the latest increase in average cost burdens was the largest since October 2014. Manufacturers cited higher steel prices in particular, alongside generally rising raw material costs, including oil.

That oil prices will increase in 2017 is a near-given.  Following agreements on oil production cuts from the major exporters, we can anticipate oil price stabilization at least in the high 50s, and possibly into the 60s.  The only downward pressure at the moment is the rising strength of the dollar.  An increase in oil prices will automatically have an inflationary impact on virtually all segments of the economy.  Likewise, as Europe begins to recover, increased demand on US exports will add upward price pressure. What remains to be seen, however, are the potential impacts of any trade-policy changes coming out of the new administration.  Tightened trade policies will likely have a medium-to-long term inflationary impact as well.

This steady growth in price inflation is similarly reflected in yesterday's CPI-U release.  Seasonably adjusted, November saw a 0.2% increase month over month, and the index rose 1.7% for the year.  That's barely below the 2% figure set by FOMC as their inflation target.  The greatest contributor to this rise continues to be the shelter and gasoline indexes.  Shelter rose by 0.3% in November, however the gasoline index rose 2.7%.  That will continue to rise as oil prices normalize in 2017.  The energy index as a whole rose 1.7%.

12-month CPI Not Seasonably Adjusted   Source: Bureau of Labor Statistics

In her post-announcement press conference on Wednesday, Ms. Yellen reaffirmed their inflationary target of 2%, however the way she addressed that was a bit interesting.  She indicated rather emphatically that while the committee was concerned about inflationary levels that are below 2%, they were also very concerned about inflation exceeding 2%.  The implication in her statement was that steps would be taken to prevent any sustained rise above that level.  At present, all signs indicate the economy is moving towards just such a rise.

What I take from all this is that the projection for three rate increases in 2017 may either be an underestimate or one of those increases may see more than the 0.25% target increase to which we have become accustomed.  The pressures on price at the moment feel a bit like a coiled spring, and if any of those downward pressures are removed, the Fed may feel compelled to react swiftly to prevent an uncontrolled rise in inflation.  This will be especially true as the "all items" level rises and returns to a normal level above the "all items less food and energy" line. 

The wildcard for 2017 remains the incoming Congress and Administration.  Consumer confidence is surging at the moment, and when consumers are confident, they buy.  There is anticipation that 2017 will see significant reforms both in regulations and in tax structures.  (I'm less optimistic that such reforms will materialize, however that's a topic for another day.)  That pro-business anticipation is adding to corporate confidence, and just like consumers, when corporations are confident, they also increase spending. 

As we head into the new year, it would be prudent to pay close attention to the various public appearances made by the fed governors.  If inflation is showing signs of increasing beyond the pace they have forecast, our first indications will be in changes in tone from the various FOMC members.  We will also pay close attention to the forward guidance offered in key 1Q17 earnings releases.  An increase in optimism in that guidance will be another signal that higher inflation is on the horizon, and another signal that the Fed may be forced to adopt an even more hawkish policy than they signaled on Wednesday. 

Happy Trading

Bull Flag in BX Above 50% Retracement

Blackstone Group, LP (NYSE: BX) broke above resistance and then penetrated the 50% Fibonacci retracement level on strong volume to end last week's trading.  Since then, the Financial asset management stock has consolidated into a traditional bull flag pattern, showing strength to the upside.

BX Daily Chart

What's encouraging about this flag is that it has formed above the strong resistance level marked by the August 2016 peaks.  The top of the flag is at the next resistance level on the chart, however as that will be part of any breakout from the flag, it's not an area with which we are concerned.

It's work noting the multiple bottoms that occurred in January, February, and July.  The flag now sits at the neckline of those bottoms.  The double bottom pattern that completed in October and November reached its target price in the current flagpole surge, and is partly responsible for the consolidation that's formed this flag pattern. 

The RSI(9) oscillator is confirming the bullish trend with a series of rising highs and rising lows that match the highs and lows on the price chart.  That, for the present, is signalling additional strength to the upside.  You'll recall that we primarily use the RSI(9) oscillator for divergence or confirmation patterns, although a cross of the 21 moving average (in red) is also a fairly reliable signal in itself.

What remains to be seen is if the volume pattern is indicative of climactic activity or if will confirm a resumption of the uptrend.  What we are watching for is a close above the flag pattern on high volume.  Our price target on a long position is such a setup is between 31.88 and 32.47, marking the 61.8% to 76.4% extensions of the flagpole.  The 61.8% level sits at another resistance line, so we do have to be cognizant of potential consolidation as price reaches that level.

The stock has a dividend yield of 5.70%, so the prospects of higher interest rates should not impact it for the foreseeable future.  Stocks with a yield closer to 2-3% will experience greater impact as they begin to compete with shorter term bonds that are seen as much safer instruments.

The next earnings announcement is before the open on 26 January 2017, which is well beyond the time frame for any swing trade we may open.  Likewise, we don't anticipate another dividend being recorded before the first week of February.

The single caution flag on the chart is a very strong area of resistance that is a convergence of a horizontal resistance line, the 61.8% retracement line, and the 23.6% extension line.  It's worth noting that the first day of the flag (after the pole top) hit resistance at precisely that location, and it retreated on very high volume.  Whether or not there's still significant supply at that level has yet to be tested, but we do need to be prepared for a swift exit if we stall there again.  A third test of that line may be the one that penetrates, but there's significant downside risk in the interim if we bounce off it on this attempt.  It would be better to exit at that point and wait for that third test before hopping in for the remainder of the ride.

Keep in mind that trading in general will begin to diminish next week, as traders begin to exit for the holidays.  Next Friday marks the start of Christmas weekend, and the holiday is celebrated on Monday the 26th.  Expect lighter than normal volume next Friday as traders turn it into a 4-day weekend. Once this stock triggers the setup, we'll look to be in the trade no more than four days, and want to be out of it before the close on Friday regardless.  The week between Christmas and New Years will be extremely light volume, and that poses a bit more risk to our trading style than we prefer.

Happy Trading.

Markets Adjusting for Rate Hike and Yellen's Hawkish Press Conference

Today's quarter-point increase in the Fed Funds rate came as no surprise to anyone.  What followed, however, was the most hawkish press conference Fed Chair Janet Yellen has delivered in her brief tenure.  The official FOMC Press Release was issued at 14:00 EST.  As expected, the release cites continued strength in the labor market as well as moderate expansion in the overall economy. 
The Fed expects inflation to continue to rise gradually towards their 2% target: "Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further."  Remember that, in Fed Speak, "medium term" is defined as between two and six years.

It's important to note that today's vote to increase rates was unanimous. Up until this point, there were at least three staunch doves voting against any rate hikes.  That it was unanimous signals a shift in the overall tenor of the committee and may be a harbinger of a more aggressive monetary policy going forward.

The significant change in today's policy announcement comes in the forecast for additional rate increases over the next three years.  Prior to today's announcement, the market was anticipating two quarter-point interest rate hikes in 2017.  The signal today, however, is for three.  Now, Ms. Yellen did caution that not all members are on board with that projection.  As a result, we can anticipate more volatility than usual around the monthly key data releases since the market will need to assess how the FOMC members will interpret the data and how that will influence a potential rate hike in March.  We're likely back into a "good news is bad" scenario where positive economic data creates a selloff out of fears of an additional rate hike.

In her post-announcement press conference, Ms. Yellen acknowledged some of the challenges facing the job market while issuing a veiled caution that the political rhetoric may not match the actual causes.  She specifically mentioned increased technology and automation as significant factors in workforce reduction saying, "For decades the pace of technological change in manufacturing has outstripped that of the economy as a whole. So manufacturing firms have found it easier to continue producing by reducing their work forces."  In other words, the problem is not all due to outsourcing and bad trade deals. Changes in the overall technical infrastructure are major contributing factors, and this rapid rate of change will be a fact of life for the foreseeable future.

On several occasions, the questions offered ample opportunity to opine on the President-Elect and the policies of the incoming administration.  To her credit, the Fed Chair refused to take the bait.  Specific to Mr. Trump's statement that he would not reappoint her, she offered, "I do intend to serve out my four-year term. I haven't made any decision about the future. I recognize I might or might not be reappointed. It's a decision I don't have to make and don't have thoughts on at this time."

 She took the opportunity to repeat several times that the independence of the Fed is a concept with which she fully agrees, and also pointed out that the 4 year term of the Fed Chair is not coterminous with the 4 year Presidential Term.  She made it a point of saying that it was setup this way for a reason, and that it was a very solid practice that has served the nation well.

When pressed on the stock market, she stated, “We’re operating under a cloud of uncertainty at the moment.” Her comments were an acknowledgement that the interpretation of the post-election surge in stock prices represented an expectation of lower corporate taxes, lower regulations, and an overall business friendly environment.  That's the popular interpretation of what we're seeing, however it's not an interpretation I share.  Rather, I believe we're seeing the natural market reaction to the resolution of uncertainty - i.e. the extremely contentious US presidential election - coupled with growing consumer confidence heading to the period of a traditional Santa Claus Rally.  In my view, the post-election surge we're seeing would have occurred regardless of the winner.  It's doubtful that there is this much movement based on the anticipation of what Congress will end up doing with taxes and regulations following at least a full year of debate. 

One factor that the market will weigh over the coming weeks is the impact of the new Fed projections for interest rate targets through 2018.  Both years are now tracking higher in projections than they were a day ago. The median projection for 2017 is now 1.375% (up from 1.155%) and 2018 saw a similar increase to 2.125%.  The target for 2019 is 3.00%. 

Interestingly, Ms. Yellen's opening statement made no mention of the global economic environment.  That comes as a bit of surprise on the heels of Mario Draghi's statements in last week's ECB announcement, coupled with the specter of the potential Article 50 Brexit invocation in the first half of 2017.  Her only mention of the historically low comparable price of oil was in the context of it being transitory: "As the transitory influences of earlier declines in energy prices and prices of imports continue to fade, and as the job market strengthens further, we expect overall inflation to rise to 2 percent over the next couple of years."

All three US major stock indexes retreated following Ms. Yellen's press conference.  We can expect to see a bit of volatility over the next few days as the market digests what FOMC has forecast for the coming year.  In addition, be ever mindful of the stock market truism, "buy the election; sell the inauguration."  Of course, volatility provides excellent short-term trading opportunities, so we'll be closely watching what develops as we head into the end of the year.

Happy Trading

Key Points to Watch in Wednesday's FOMC Announcement

As of today's market close, the 30-day Fed Funds Futures have factored in a 95.4% probability of a .25 bps increase in interest rates when the Federal Open Markets Committee (FOMC) releases their December announcement at 14:00 EST on Wednesday.  This would mark the first rate hike since December of last year, and it would raise the Fed Funds rate to a target range of 0.50% to 0.75%.  The market would then settle rates around 0.63%, up from the current 0.38%.  The equities market expects the rate increase and has largely included it in stock prices. 

The actual monetary policy move is of little substance, tomorrow.  What traders and investors will be watching is the tone of the monetary policy announcement coupled with the statements and responses Janet Yellen provides in the post-announcement press conference.  That tone and her responses may significantly move the market heading into tomorrow's close.  Here are some points that we are watching.

• Commentary regarding unemployment.  The most popular number watched by the press and typically referenced by Yellen is the U-3 number which currently sits at 4.6%.  We know that she will reference that number and will likely cite it as an indication that the nation is at "full employment."  In past conferences, however, she has also made passing reference to both the U-6 number (9.3%) and to the Civilian Labor Force Participation Rate (62.7%.)  Those numbers paint a less rosy picture of the employment situation and we'll be watching how Yellen presents either of them in her commentary.
• The next major number we expect the Fed Chair to reference is the Inflation number.  It currently sits at 1.64%, slightly below the Fed target of 2.0%.  Since changes to monetary policy typically take approximately 6-months to have and effect, it's no surprise that the Fed will move ahead of their target.  It's like turning an ocean liner - it takes time to get the behemoth pointing in the right direction.  What we will be watching, however, is her assessment on the rate at which she expects inflation to increase.  This will offer some guidance as to how quickly rates will be increased in 2017.
• We anticipate some commentary, at least in the press conference, regarding potential tax and regulatory changes from the incoming Congress and Administration.  A somewhat adversarial relationship is developing between the President-Elect and the Fed Chair, and the latter has expressed concern in recent weeks over the possible inflationary impact the theoretical domestic policy changes will have on our overall economy. How she references this and the tone she takes will provide more clues into how swiftly the Fed believes they must move in raising interest rates.
• Some reference to "global economic headwinds" will likely be made, and that will most likely occur in both the announcement and in the press conference.  What we will be watching is whether those headwinds are perceived to be holding steady, increasing, or decreasing.  She may put this in the perspective of Brexit as well as the recent ECB announcement.  In the past, the economic conditions in Europe have caused the Fed to take a more cautious approach domestically.  Any improvement in the Fed's perception of those conditions will potentially signal a more hawkish economic policy in the US.
• We must pay careful attention to the phrasing of certain terms.  Once we have the announcement in hand, we need to compare the exact wording with the prior announcement.  Dropping a single word in a phrase can signal a fundamental shift in outlook, so we will need to scrutinize any changes to prior announcement specific to the rate at which the economy is expected to grow.

Current market expectations are for two rate increases in 2017.  These will most likely come in June and December.  At least, that's what the Fed Funds Futures have currently factored into pricing.  From a trading perspective, that is what we are attempting to anticipate.  A more aggressive monetary policy may signal a potential rate increase in the February or March time-frame, and we'll see stocks react accordingly.  Given the current inflation and unemployment levels, it's highly unlikely that the Fed will signal a slower rate of increase, although that more aggressive posture is a distinct possibility.

The final major consideration is something that will not be referenced in tomorrow's announcement, however it's something the markets will have to factor into pricing over the course of the next month.  There are currently two vacancies on the Fed's Board.  These will be filled by the President-Elect, and he will have the ability to make those appointments immediately following his inauguration.  Given that he has already expressed displeasure with the dovish policies set forth by Yellen, it's almost a given that his two appointments will have a hawkish outlook.  Their presence on the board will increase the likelihood of a more rapid normalization of interest rates than we've experienced thus far.  Expect this to be factored into market pricing the closer we get to the inauguration.

Happy Trading.     

Evening Star Signals End of Wave 3 in BOFI

An evening star candle pattern developed over the last three days in BOFI Holdings, Inc. (Nasdaq: BOFI).  The highs of the pattern form a consistent resistance line, and the long wick in yesterday's candle signals short-term trouble ahead on the long side.

BOFI Daily Chart

The stock has been in a flat correction since it's 25 November 2015 4:1 stock split.  As with other financials, signs of life manifested in the post-election exuberance rally starting 9 November 2016, and a short 5-wave impulse appears to be underway.  This wave has taken out the highs of the post-split pattern, however it remains to be seen if this is a longer extended Wave 1 or if it will culminate in a Wave A top.  For the purposes of the swing trader, however, that's largely irrelevant in the short-term.

At least two classic Elliott Wave patterns have completed.  Wave 2 was a well-defined A-B-C flat correction, and from there we're either in the early stages of a Wave 3 or we've just completed Wave 3.  We don't yet know, although other indicators on the chart suggest Wave 3 is over and we're into Wave 4.

Resistance at the high of yesterday's candle appears significant, as does the higher than average volume we recorded on the long red candle that developed.  That pattern increases the significance of the doji star that completed the day before, and is a decidedly strong bearish reversal pattern.

The stock is currently trading at an extreme level above its 10, 20, and 30-day moving averages.  In fact, it's the furthest the stock has ventured from its moving averages on this entire chart. Reversion to the mean implies a retreat is imminent, at least back to the 10-day, although a retreat to the 20-day is more common.

The RSI(9) oscillator is drawing a bearish divergence, not only on the highs, but also on the lows.  While the stock was recording higher lows, the RSI was drawing lower lows.  Now, you'll find some traders that would also place credence in the double top pattern on the RSI.  Personally, I ignore chart patterns like that in the oscillators.  Patterns such as double tops, head and shoulders, trend-line breaks, etc. work on the price charts simply because traders set open and close orders at those levels and they become self-fulfilling prophecies.  That type of stop and limit order potential isn't present with the oscillators to any great degree - at least, not in an automated fashion - so, in my view, the appearance of patterns in oscillators is an interesting trick of the mind, but it's not a trade setup.

The exception to that is the concept of divergence.  The oscillators we use are showing the strength or weakness of trading behavior, so it is certainly significant when an oscillator is not matching the highs and lows being drawn by the stock price.  Divergence doesn't immediately result in a buy or sell order, but it does provide warning signs that a change in trend may be in the offing.

You'll notice that I'm also showing the Slow Stochastic (14,3) oscillator on this chart.  Again, the Slow Stochastic is showing us trend strength or weakness based on the theory that stocks tend to close near their daily highs in an uptrend and near their daily lows in a downtrend.  In this case, we see that the oscillator just crossed its signal line to the bearish side, and did so above the so-called "overbought" line of 80.  The concept of overbought and oversold in these oscillators is an unfortunate misnomer, but since that's the common term for the lines, I use them here.  What's important in this case, is that the crossover signals short-term weakness.  Nothing more.  In fact, you can see that the other two most recent crossovers above 80 were only one or two day moves.  I don't trade on oscillator signals alone, and I don't recommend anyone else do so, either.  They are simply additional data points in our overall analysis arsenal.

Returning to the chart, the key here is the evening star (bearish reversal) and the Elliott Wave count (signalling a potential Wave 4 correction.)  The probability here is a move to the downside.  I've highlighted the target area in green, and that's our short-term play.  Wave 4 should not penetrate the top of Wave 1, so once we hit that area we'll be looking for a bullish reversal and will attempt to play that move as well. Now, Wave 3 is shorter than Wave 1, so we know Wave 5 will be shorter than Wave 3.  (Wave 3 can't be the shortest of 1, 3, and 5.)

Be aware of external events that can impact the market, this week.  The December FOMC meeting is tomorrow, and the market widely expects the Fed to increase interest rates in their 14:00 EST announcement.  That's factored in, and it's part of the reason financial stocks have done so well for the last month.  Pay extremely close attention to both the announcement letter and Fed Chair Janet Yellen's post-announcement press conference, however.  The market, tomorrow, will move based on the forward guidance she sets.  We will be listening for any signal as to the number of rate hikes anticipated in 2017 as well as any statements around anticipated inflation levels and economic growth under the new Administration.  Tomorrow's is a press conference we as traders cannot ignore.  Be prepared for volatility in the closing hours, tomorrow.

Happy Trading.

ADI Sets Up a Short-Term Double Top Pattern

Following a significant gap up on 22 November 2016, Analog Devices, Inc. (Nasdaq: ADI) hit a strong area of resistance at its 52-week high.  The stock has now bounced off four touches of the resistance line and is showing some short term weakness following a pronounced double top pattern.

ADI Daily Chart

The extremely narrow width of the double top suggests that this is a very short term trade.  Now, it's important to remember that the double top is not yet confirmed.  By definition, confirmation only occurs following a close below the neckline of the pattern.  That doesn't, however, mean we don't have trading opportunities in the interim.

There is a diagonal support line (drawn in dashed green) that extends from a 25 July peak, and that support line sits just below today's close.  It represents a good entry level for a short should we trade below that line with conviction.

The candle pattern also favors a short-term downside move.  Yesterday's candle was very close to a bearish engulfing pattern, and the two-day pattern that includes today certainly did complete it.  Further, we've now traded back below the low of the gap that started the upward move to the 52-week high. 

Volume has been on the decline since the gap day, with the only other significant volume move coming on a major test of supply on 1 December.  That move closed the entire gap with the longest solid bar in either direction on the entire chart.  The move back up to the 52-week high was on gradually decreasing volume, indicating the demand for the stock was beginning to wane.

The sense of weakness is confirmed by the bearish divergence in the RSI(9) oscillator.  The relative strength in the subsequent upside move didn't come close to approaching the highs drawn in the RSI during prior move.

There are four potential plays setting up on this chart:

1. Aggressive traders may wish to play a further move to the downside.  A good entry would be just below both the diagonal support line and the 38.2% retracement line of the full height of the double top.  A slightly more conservative entry would be just below the low of today's candle.  Either way, an entry at this point would set a short term target of the upper green shaded area.  Protective stops should be close.  We want a quick exit if there's no strength to the downside.
2. A more conservative entry would be following a close below the neckline.  The target in that case would be the lower green shaded area.  Be aware of some support just above that area (blue dashed line), and also be aware of the potential for a pullback before the final move begins.  It's increasingly common for market makers to take out those short sell stops, then drive the price back up above the entry point to shake out the weak money before finally allowing the pattern to play out.  Be careful not to set protective stops in that zone between the 76.4% and 100% levels since that's where they will be gunning to take them out.
3. If neither of those moves occur, a third potential play will be on a close above the 52-week high provided that move occurs with confirming volume.  In that situation, a protective stop would be just below the 23.8% line marked on the chart, and we'll want to set a daily trailing stop below the prior day's low, following the stock up until we're stopped out of the position.
4. Finally, today's candle is a spinning top - indicating indecision - and it's also the narrowest range of the last seven days.  This offers an opportunity to setup trades in both directions.  This would involve placing a buy stop just above today's high and a sell stop just below today's low, pairing them with a one-cancels-other order.  (If the buy triggers, the sell is cancelled, and vice versa.)  The protective stop for each opening order would be set and the same level as the opposite order. This type of setup allows us to capitalize on the indecision signaled by today's candle, although we do run the risk of a wide range taking out our protective stop before the move completes.  Because of the narrow stop, this type of trade shows lower risk, however that same narrow stop does increase the risk of it being tripped.

When analyzing a chart for a short-term trade, it's helpful to consider how we'll play it regardless of the direction of the move.  While the chart may be signalling a downside move, as it does in this case, we should never turn a blind eye to the possibility of the exact opposite move developing.

Happy Trading.

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.

Using a Narrow Range Scan to Find and Possibly Enter Swing Trades

The amount of time a swing trader spends in front of a trading engine entering or managing specific trades is dwarfed by the amount of time that trader spends researching and analyzing trade setups while the market is closed.  Effective swing trading takes a significant amount of time and effort, so any tools we can use to reduce the manual portions of the job are extremely beneficial.

Fortunately, for the 21st century swing trader, there are numerous online sites that assist in scanning for trade candidates.  Some are free (or sort of free) like Finviz.com or Chartmill.com, whereas others such as Stockcharts.com offer subscriptions but far greater scripting flexibility to search for desired trade setups.  Personally, I use all three of the sites I've listed since each has a unique approach and each is capable of identifying stocks that are suitable for the watch list.

What the swing trader learns in their first year or so is that there is no magic setup, nor is there a magic indicator that will guarantee the stock will move in the direction you anticipate.  Some setups and indicators will improve our probability of success, however in the end, it all comes down to our own ability to read the hidden market psychology being revealed by the charts and indicators tightly coupled with our own discipline in managing risk, managing our capital, and determining the entry and exit points that meet our own style and risk tolerance. 

The setups that I trade naturally change as market conditions change.  The market is a very dynamic and moody beast with numerous personalities.  The setups that are working well in this post-election market exuberance period (which, for me, are momentum and breakout plays) will not work well once the market either consolidates or corrects in the post-inauguration period.  We'll need to adjust and determine what strategies to implement when we see the market's mood at that point.

One type of scan I use to identify opportunities in most market conditions is a Narrow Range scan.  The details of the theory behind the narrow range, along with several trading strategies that employ it, are covered in excellent detail in "The Master Swing Trader" by Alan S. Farley. (Farley, A. S. (2001) The Master Swing Trader - Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities, McGraw-Hill, New York, NY.)

If you use Stockcharts, you may paste this scan directly into the advanced scan engine:

[type = stock] AND [country = US] AND [sma(63,Daily Volume) > 1000000] and [[exchange is NYSE] or [exchange is Nasdaq] or [exchange is Amex]]

and [Close >= 25.00]
and [Close < 100.00]

//
//  This scan finds stocks that demonstrate an NR7 pattern.
//

# See if today's range is the smallest in the prior six days.

and [today's range < yesterday's min(6,range)]

# Check for trending prior to entering the range.

and [7 days ago adx line(14) >= 30]

and [
[group is ConsumerStaplesSector]
or [group is CyclicalsSector]
or [group is EnergySector]
or [group is FinancialSector]
or [group is HealthCareSector]
or [group is IndustrialSector]
or [group is MaterialsSector]
or [group is TechnologySector]
or [group is UtilitiesSector]
]

It's important to understand that we do not automatically enter a trade simply because the stock has drawn the narrowest range of the last seven days.  The scan simply returns a list of candidates for further analysis.  From there, we need to analyze the chart to determine if there is a potential move imminent, and if so, whether or not the risk vs reward is worth the trade.  From there, we need to determine how best to play it.  Let's look at one that popped up on the scan, today.

DXCM Daily Chart

Dexcom, Inc. (Nasdaq: DXCM) started a decline on 28 September 2016.  It has either completed a truncated 5th wave in that decline, or it's in what will be an extended Wave 5.  Which way that plays out, we don't yet know.

We can see that, following the low on 3 November, DXCM retraced 38.2% of the full impulse before declining back almost to the full extent of the downtrend.  At a fairly pronounced support level, we can see that DXCN entered a consolidation period, balanced neatly between a strong support line and a strong resistance line.

That bit of congestion culminating in a narrow range day is precisely what we're looking for.  It's the type of situation that Farley refers to as a "coiled spring."  The odds favor a short but explosive move.  The challenge, though, is we really don't know which way the move will go. 

You can see on the chart that I've highlighted two target areas in green.  A move to the upside will likely penetrate the area topped by that prior consolidation region.  A move to the downside will likely run into some congestion where the prior decline stalled. 

One of the methods Farley mentioned in trading the Coiled Spring is to place a buy opening stop above the high of the narrow bar and a short sell opening stop below the low of the narrow bar.  You'd set this up as a single trade with a "one cancels all" order, so whichever one triggered would automatically cancel the opposite trade.  It's a low risk setup in that the protective stop - set to the same level as the opposing open level - is very narrow.  We're not risking a lot of capital.  What we do risk, however, is being stopped out almost immediately due to intra-day volatility. 

To mitigate the intra-day risk, I prefer to set a start-time of 10:01 EST on the trade.  This, at least, keeps us out of that first 30-minutes where wild swings are the norm.  A second mitigating technique I'll use is to set another condition on the opening order such that the overall market must be moving in the same direction as the stock.  This avoids us having to swim into the current if the stock moves contra-market for a period of time. 

Once in the trade, we'll manage the overall play very closely.  This is a short-term explosive setup, so we expect to be in the trade for 2 or 3 days at most.  We need to watch how the stock behaves as it approaches either of the diagonal support or resistance lines marked in green.  At the first sign of weakness, we're out.  There are also three significant moving averages that are hovering over us to the upside.  Any of those could act as resistance, as we saw between 10 October and 11 November with the stock constantly bouncing off the 10-day moving average.  Again, at the first sign of waning momentum, we need to exit the trade.  This is a setup for a quick profit, not a home run.

One final note on this type of setup.  Don't be afraid to immediately take the opposite position if stopped out quickly.  In this type of chart setup, the initial move is likely to be short and swift.  There is also decent profit potential on the reverse move after we're stopped out of the position.  That's a difficult trade to enter psychologically, but it's one I highly recommend considering. 

Happy Trading.

KHC Forms Double Bottom With RSI Bullish Divergence

Kraft Heinz Co. (Nasdaq: KHC) provides an excellent study in multiple chart patterns and signals.  The most current pattern under development appears to be a double bottom with lows on 14 November and 6 December 2016.  If confirmed, the double bottom is fairly reliable bullish pattern, although due to the growth in popularity for this pattern, more caution is needed when trading it.

KHC Daily Chart

First up on the chart is an interesting diagonal support line (in dashed green) that started out as resistance in early April.  Since that line was broken with an significant gap up at the end of April, it served as a very reliable support line until November.  We can also see that a horizontal resistance line (also in dashed green) formed in early September.  The combination of the two produced a very tight ascending triangle pattern that I've highlighted in pink.

The documentation you'll find on the ascending triangle will tell you it's a bullish pattern and to anticipate an upward breakout.  That has not been my experience, especially when there are as many touches of that resistance line as seen in KHC.  A bullish breakout requires demand, and my experience has been that the most profitable plays in a triangle is to the side of the hypotenuse, not the resistance leg. 

That certainly came to pass with KHC.  The downward break was swift and it hit the price target for that break in a single day.  The subsequent retest of the diagonal - now a resistance line - was equally profitable with another rapid retreat back to the price target level of the triangle.  Two nice profitable plays for the price of one.

This now sets up our next pattern - the double bottom.  Once again, most books and websites will list the double bottom as one of the most reliable trading patterns.  At one time, it was.  Unfortunately, the setup has become too popular, and market specialists now engage in enough stop hunting that a pullback following the pattern breakout is more the norm.

The actual confirmation of the double bottom is when price closes above the neckline of the pattern.  I show that level on the chart with a thick, dashed orange horizontal line.  What's very common now, though, is for price to break above the neckline, trade there for a few days, and then quickly retreat back below the neckline as the specialists trap the retail traders on the long side.  If you're an aggressive trader, you can play that, keeping your stops tight.  Grab the quick upside profit, wait for it to retreat, and then go long again on a second break of the neckline.  That second break is often the true move.

Returning to our chart, though, notice that the double bottom has formed at the 50% retracement level of the overall uptrend.  That's an extremely strong support line, especially since it coincides with the highs of October, 2015 and with the top of the congestion pattern  from March to May 2016.  A retreat to the 61.8% retracement is possible, but there's a lot of support to overcome for that to happen.  The bounce off 50% is a bullish signal.

Next up is the volume pattern.  We have rising volume as ranges declined into the second bottom.  A high volume day on a long white candle coming off that bottom is a very bullish signal.  The day following was an inside day, creating a bearish harami setup, however the requirement that the bearish harami occur on a strong downtrend was not satisfied.  Therefore, we're interpreting the inside days as a bit of a pause following that high volume up day, but we're not interpreting it as a reversal.

Finally, we see a bullish divergence in the RSI(9) oscillator.  The RSI has traced higher lows in each of the major lows on the chart since early November.  That's an indication that a bullish reversal may be imminent, and that sentiment is consistent with the double bottom pattern that we're currently watching.

The target price range for this pattern sits between the 61.8% and 100% extensions above the neckline.  (We measure the height of the neck from the low of the double bottom and set a Fibonacci grid based on that height starting at the neck.  We expect price to at least reach the 61.8% extension before pulling back, although a 100% extension is also common.)

Keep in mind that the pattern is not confirmed until there's a close above the neckline.  We can trade the rise to that neckline, of course, however that's a higher risk trade than is the rise from the neckline.  Be sure to factor that into position sizing.

Remember, too, that busted patterns are also profitable.  A break below the low of the double bottom is an excellent shorting opportunity.  There are a series of support lines (not drawn) that offer target guidance, however remember that downside moves tend to be swift and steep.  (Look at the downside move out of the triangle as an example.)  As we watch this - or any - stock for the development of the primary pattern we wish to trade, always keep an eye out for an opposing trade.  Often, it's the breakdown of the pattern we're stalking that proves to be the profitable play.  Avoid being so rigid in the analysis that we miss the true trading opportunity.  Keep an open mind, and play the setup that develops.

Happy Trading.

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.

Mattel Forms Hammer on Strong Volume

Following a double top at their 52-week high on 18 April 2016, Mattel (Nasdaq: MAT) spent the remainder of the year trading in a horizontal channel that spanned about six points from low to high.  After tightening that channel nearer the low end over the last two months, Mattel signaled a break off the bottom trendline in today's trading.

MAT Daily Chart

The hammer candle that formed today did so at the 10-month low for the stock.  Now, as candlestick patterns go, the hammer (when formed at a major low) produces a bullish reversal approximately 50% of the time.  That statistic is much better than it sounds, however.  Consider that there are three possible outcomes from this position.  The stock can trade sideways, it can drop further, or it can rise from here.  To put that in perspective, there's a 25% chance it will drop, a 25% chance it will trade sideways, and a 50% chance it will rise.  That candlestick pattern suddenly sounds much more reliable, doesn't it? 

Of course, we never enter a trade simply based on a single candlestick pattern.  We need to consider the rest of the chart and determine if there are other elements that confirm the move and increase the probability of a successful trade.  One such factor is volume.  When you look at the chart, we see the second highest volume pattern since mid-June.  That implies demand - a lot of demand - entered the scene as MAT reached its low for the day.  Our odds suddenly got much better.

Look at the Fibonacci retracement grid drawn from the low to the high on the overall chart pattern.  The long tail in today's hammer just penetrated the 38.2% retracement level.  For stocks trading in a horizontal pattern as long as this one has, that's a very significant retracement level.  It would be safe to conclude that there were many limit orders to enter long positions just below that 38.2% level.  It would also be safe to conclude that there was a significant amount of short covering at that level, as well. 

Notice next the support/resistance line (dashed blue) right at our open today.  We broke below it for much of the day, but what's significant is that we pushed back above that level and managed to close not only above our open, but near the high for the day. 

Not shown on the image in this article are the RSI(14) and Slow Stochastic(14,3) oscillators.  Now, I don't enter positions based on technical indicator signals, however they are extremely valuable in adding confirmation to what the chart is already telling us.  In this case, the RSI(14) broke back above 30, today, and the Slow Stochastic(14,3) had a bullish crossover below 20, today.  Those are two extremely bullish signals on top of a chart that is already telling is to go long.

Now, this is a swing trade, not a long term position trade.  We are looking at a brief move of perhaps a week or less.  You'll notice two parallel dashed lines drawn in green.  Our target is that upper green line, and you'll notice that it's sloping down.  We're looking at about a two-point move at most, and this is a trade we need to exit at the first sign of trouble.  Since it's a pure momentum play, our stop is going to be just below the lower channel line, not below the low of today's hammer.  That increases the risk that we'll be stopped out of our trade for a loss, but if this stock doesn't take off immediately then the signal is invalid and we want out quickly, anyway. 

So that's the overall play.  We'll monitor futures before the open, and then watch the market for the first twenty minutes.  We want the market moving in our direction, and if it is, we'll enter the trade with a stop limit order between 29.61 and 29.66 with a start time of 9:50 EST.  (Meaning, we won't enter a position before 9:50 EST.  It's too easy to get caught up in the extreme volatility of the open.)  Our protective stop will be 28.98, and our price target will be 31.66.  That gives us a 2.88:1 reward to risk ratio.  It's a hair under the 3:1 we prefer, but it's still a solid gain. 

If we are not stopped out during the day, tomorrow, we'll look to adjust our stop to breakeven as soon as is practical.  This stock has tended to move quickly off its lows in the channel, however our objective is always to first identify risk, reduce risk, eliminate risk, and then protect any profits. Let's see how this one develops. 

Happy Trading.

Bearish Divergence in FITB - Nearing a Top or Just a Pause?

Fifth Third Bancorp (NYSE: FITB) appeared on one of my pullback screens, today, and upon closer inspection, it is indeed tracing an interesting, and somewhat conflicting, pattern on the daily chart.   It's worth a closer look.

FITB Daily Chart

FITB has been in an uptrend since 11 February 2016, however that's the first point of contention in the analysis of this chart.  In conducting an Elliott Wave analysis, we must first determine the point of origin for the impulse wave.  One possible point is the red "O" labeled at the low on 11 February.  It looks clear enough, right?  That's obviously our starting point for this impulse, isn't it?  Well, it does indeed trace five well-defined sub-waves, so on that score it qualifies.  The problem, though, is that the low on 13 May - a low that would mark the bottom of sub-wave (iv) in this case - is lower than the high of 21 March - a high that would mark the top of sub-wave (i).  That is a violation of one of the Elliott Wave rules in which wave 4 cannot penetrate wave 1.  So, unless we accept this rule violation, the wave count in red cannot be correct.  Note that Elliotticians are split on this topic, with many saying that this rule is more of a guideline than a hard-and-fast requirement.  I'm inclined to agree with them since, in most chart analysis, "close is close enough."

Let's follow-through with the red wave counts, however.  If the red counts are correct, then Wave 3 is longer than Wave 1, albeit by a hair (4.85 to 4.66.)  That satisfies the rule that Wave 3 cannot be the shortest of waves 1, 3, and 5.  Wave 5 is somewhat troubling in that it's an extremely steep impulse that far exceeds the angles of waves 1 and 3.  Now, that's not a rule violation, but it is definitely rare.  Looking at the pattern drawn by waves 2 and 4, there's really no problem there.  They adhere to the alternation rule, and wave 4 doesn't penetrate wave 1. 

If this count is correct, then we likely reached the top of this 5-wave impulse on 23 November.  That would put us into the A-B-C corrective pattern now, and that pattern has yet to fully develop.  Is the red count the correct one?  Possibly.  Let's look at the green count for comparison purposes.

The origin of the green count would be on 6 July 2016, and marked with the green "O."  Waves 1, 2, and 3 look pretty straightforward, and none of the subwaves violate any of the rules or even the guidelines.  We (so far) have good alternation between waves 2 and 4, although it's more common for wave 4 to be the steep retracement, not wave 2.  The steep acceleration seen in wave 3 is very common for that wave, so that's consistent with the overall pattern as well.  The shape of wave 1 is more consistent with the shape of an impulse where, whereas the shape of the red-labeled 1 is more consistent with the shape of a corrective wave.

If we were only considering the price chart, I would be inclined to consider the green wave count to be the correct count.  Chart analysis, however, is much more than just the patterns produced by price alone.  With these two wave counts in mind, let's turn our attention to volume.

Look at the three areas I've highlighted in orange.  Demand is certainly abundantly present.  Those black volume bars tower over their neighbors, and far exceed the 50 period volume moving average.  The only troubling sign is that each subsequent set of spikes is lower than the previous set.  Demand is starting to wane - a sure sign that this stock is running out of gas.

This is confirmed at the bottom of the chart where I saw the 9-period RSI.  The RSI is the "relative strength index" developed by Welles Wilder, and - without going into the actual formula - it measures the relative amount of gains vs the losses in the specified period.  There are several ways of using the oscillator in technical analysis, and one of the most reliable methods is to detect divergence between the RSI and the stock price. 

A bullish divergence would occur if stock prices were tracing lower highs but the RSI was tracing higher highs.  Conversely, a bearish divergence would occur if the stock prices were tracing higher highs but the RSI was tracing lower highs.  That, in fact, is what we see on our chart.  I mark the comparison highs with a vertical black dotted line, and you can clearly see that the RSI is tracing a bearish divergence.  This divergence is another major indication that the stock is running out of steam, and a breakout to the downside may soon follow.

The last three candles are troubling, as well.  2 December saw a long red candle on volume that was higher than the 50-period average.  That, coming off the new high of the day before, is a bearish reversal candle.  It was followed immediately by an inside day where the stock closed below its open.  Today it traced a hanging man candle - another bearish indication when this pattern appears at the top of an uptrend.

When we take volume, the RSI bearish divergence, and the current candle patterns into consideration, I'm inclined to believe that the red count is the correct count.  It's still not certain, of course, but all indications are that this stock is due for a bearish reversal.  Before we start to analyze potential price targets to the downside, I'd much prefer to see an indication that the reversal is in progress.  A quick glance at the chart, however, shows a very attractive target between 21.73 and 22.07, bounded by a strong support line at the base of the last major upthrust and the 38.2% retracement of the overall pattern.  We have yet to move in that direction, of course, but the warning signs are clear that this stock's upward run may be nearing its end.  I'll be avoiding long positions in this stock for the time being.

Happy Trading.