A Change in Character?

After peaking just before Christmas of last year with negative RSI momentum divergence, NTES, has gone on to fall more than 40% before it bottomed in late May. Since that time, it has begun to make higher highs and higher lows, the indication of a change in character. Price currently sits just under the neckline of an inverse head and shoulders (IHS) bottom reversal pattern and the long-term (red) downtrend line. While price is still under a falling 200 day moving average it recently crossed above its 50dma which has now curled higher.  These are all constructive elements an investor would like to see before attempting to catch this falling knife

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A confirmed (with higher volume) break and hold above the green horizontal resistance, the upside target for NTES is the March high (at T1), a nice 20%+ gain. A confirmed entry with a stop just below July 11th ‘s low provides a better than 4:1 reward to risk ratio.

While the NTES setup is compelling, the recent move off the right shoulder was not ideal.  from a volume standpoint so it makes this IHS pattern suspect. While volume plays an important role in the Head and Shoulders Top, it plays a crucial role in the Head and Shoulders Bottom. Without the proper expansion of volume, the validity of any breakout becomes suspect. Volume levels during the first half of the pattern are less important than in the second half.

  • Volume on the decline of the left shoulder is usually pretty heavy and selling pressure quite intense. - Check
  • The intensity of selling can even continue during the decline that forms the low of the head. - Check

After this low, subsequent volume patterns should be watched carefully to look for expansion during the advances.

  • The advance from the low of the head should show an increase in volume – Check
  • After the reaction high forms the second neckline point, the right shoulder's decline should be accompanied with light volume as it is normal to experience profit-taking after an advance. - Check

Volume analysis helps distinguish between normal profit-taking and heavy selling pressure.

  • The most important moment for volume occurs on the advance from the low of the right shoulder. – Sort Of

The most recent advance from the right shoulder started well but is ending with lighter volume than desired. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout.  While increasing volume confirms the breakout and pattern, just because it isn’t there does not mean the pattern won’t play out to completion, it just means the probability is not as great and why it is suspect.

Looking for LUV in All the Right Places

After failing at 3 attempts to break and hold above the $66 level late last year, Southwest Airlines stock, LUV, was eventually taken out to the woodshed and beaten with a stick. Price fell ~25% as sellers had their way until it hit the $50 mark where willing buyers showed up in numbers and provided a respite for the decline. As you can see in the chart below that support level acted was important the past too as the 2017 correction found a bottom twice in exactly in the same area.

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Since bottoming in May, price has retested that same $50 level and each time buyers have stepped in pushing prices higher, where sellers take back control at $53. For now, LUV is stuck in a $3 range and looking for a catalyst for that to change.

Picking bottoms is hard but I have found that a downtrend followed by sideways consolidation that last for at least 6 months and then break higher provide a much high probability trend reversal follow-through and investment gain opportunity.

It doesn’t mean it won’t turn out to be a good investment opportunity if the consolidation is cut short. In fact, in the case of LUV, if the market wants to move higher from here right away, the first upside target is the 200 day moving average, a near 7% gain.  A bullish market tailwind that would push prices even higher, point to the chance of it filling both open gaps made during the most recent decline which makes it a much more compelling (20+%) opportunity.  

When 10 is More than 100

Through the first half of the year, as you can see in the chart below, just 10 stocks (2%) of the SP500 index have made up more than 100% of the indexes return this year.

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While this is not what stock bulls want to see, it isn’t necessarily negative … at least not yet. Ideally, the more stocks participating and contributing to the indexes (positive) return the better. What would be healthy for higher future stock prices is to see strength rotate from the above 10 companies and across a wider breadth of not just companies but also sectors.

When Bad Turns Good - Mid-Term Election Year Stock Market Performance

Midterm election years tend to be the weakest of all in the 4 years of the Presidential cycle for the US stock market as you can see in the 115 year chart below.

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Zooming in on the midterm election cycle year details in the chart below, we see they are marked by a stock market peak in the spring and followed by a yearly low in the fall.

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Since 1913, on average, the DJIA has fallen more than 20% from the post-election year high to the midterm election (subsequent) year low. So far the major US stock market indices have pulled back 10% or so earlier this year falling short of the historical average. Assuming 2018 follows a similar path of the past, it appears like we have not likely seen the end of this pullback. Keep that in mind if we get additional selling pressure and probe lower in the coming months. 

What makes this interesting as investors is that since 1914, on average, the DJIA has subsequently gained more than 47% from the midterm election year low to its high the following year. Obviously, the only way to capitalize on this historical opportunity is to insure you have dry investment powder and a plan for whenever it may materialize.

I probably don’t need to remind everyone but the numbers above are based purely on what the historical averages suggest could occur, not will occur. As such there is risk in following a strategy even though it provides a historically higher statistical outcome.

June 2018 Charts on the Move Video

Yawwwwwwwn.   Sideways chop within the Jan -Feb consolidation range until we see a catalyst. I thought maybe trade war fears would be enough to break the trend but apparently not.  Bulls are still in charge.  I don't expect to see a resolution for months so until then, sit back, enjoy the summer and check out this month's Charts on the Move video at the link below  ...