INVESTMENT EDGE
My latest video recapping notable activity in last month's markets is posted at the link below.
The summer grind continues. Still waiting for the impetus to push US stocks out of their longstanding trading range. European and Japanese equities are in serious need of a lifeline.
After a spectacular bull run of almost 375% from the 2011 bottom, the Biotech index (IBB) ran out of gas topping in July of last year. You can see price created a bear flag (#1) immediately after registering its last negative RSI momentum divergence. The flag occurred around the 200 day moving average which was flattening but still in an uptrend and had provided important support in the past. The break out of flag #1 to the downside not only created the biggest and fastest decline of any week since the 2011 bottom, but also another bear flag (#2). Patterns on top of or within patterns occur in strongly trending markets (both bull and bear). At the top of flag #2 price tried to retake the 200day moving average but was rejected and began its next leg down, settling near the $250 mark. Since then, Biotech’s have tried to reverse the downtrend but could only muster a couple of counter trend rallies each time petering out and falling back to retest that same $250 level which tells us its hot. Not unexpectedly as with many corrective consolidation zones, this level marks the 50% fib retracement of the 2011-2015 bull run.
As with almost all stocks, Biotech’s took it on the chin last week and have once again settled back to the $250 … for the 4th time. We know the more price tests a level (from above or below) the greater the chance it will not hold. If the Brexit scare has more downside in store for stocks, I would expect IBB to fall in sympathy and the next level of support comes in the @212.5 range some 15% lower. Again, not so coincidentally, this turns out to be the 61.8% fib extension of the ’11-’15 bull market.
Stepping back and reviewing Biotechs from 50ft, it's (now) obvious we are in a bear market with lower highs and lower lows being formed. Until we see a confirmed reversal formed from a recognizable bottoming pattern this is one investment that is on the AVOID list. That is, unless you are able to short as a breakdown below current support creates a very nice risk/reward entry.
2016 will likely go down in the books as one of the toughest (in my experience) years to invest if you are a market technician. Technical analysis has been helpful but not anywhere near as it has been in the past. I have never experienced so many failed patterns both bullish and bearish. I believe it can be explained and chalked up to the fact the US stock market has been range bound for almost 2 years, while most foreign markets are languishing in bear territory.
The Italian stock market peaked in June 2014 with negative RSI momentum divergence falling almost 30% before it bottomed and rallied up to the 61.8% fib line. There it chopped around and formed a symmetrical head and shoulders pattern which confirmed in early Jan of this year gapping below the blue support line. It came to rest at important prior support (red horizontal line) and is once again chopping around trying to digest the 20+% decline. This is one pattern that did not fail but rather did exactly what was expected and met its objective.
While there is no pattern that has developed (yet), Italy has formed lower highs and lower lows while the 200 day moving average is steeply pointing south which screams “AVOID ME”. Because of the number of touches, we know the current (red) ~$10.75 support line is hot and if it should fail on another retest we can expect a much further decline. The first level of expected support would be another 20% lower at the July 2012 lows. Beyond that if further downside is on the table, we could see a retest of the 2009 financial crisis lows on the radar.
I believe in the short to intermediate term Europe is in deep trouble and their stock markets are a real reflection of that concern. From what I see and read Italy is in the top 5 of European countries in the worst shape. While anything can happen, the awful fundamentals combined with equivalent technicals is pointing to potential lower prices ahead. Until proven otherwise, long only investors should look at Italy with caution while those with the ability to short should be licking their chop
Solar stocks took quite a beating in 2011-12 that includes Sunpower, SPWR, which lost more than 80%, bottoming below $4/share. What a buy that level turned out to be for those that had the intestinal fortitude and bottom picking skills as it rose more than 1000% (trough to peak) topping in June 2014. You can see during the topping process negative divergence was created warning of weakness and of a likely correction.
The blue horizontal line at ~$18 acted as support many times prior to the week of May 9th as it finally gave way turning to resistance. After support broke, price attempted to rally back to $18 but the backtest failed and immediately turned lower.
One has to have an imagination and be slightly cross-eyed to see it but that topping pattern could be an extended, complex head and shoulders pattern. If so and it comes to fruition, the future does not look bright for Sunpower stock. The two downside targets are the $4-5 range and GULP! $0. Regardless of whether the pattern confirms or not, the series of lower highs and lower lows combined with a falling 200 day moving average should give warning to anyone holding this stock that they may want to reconsider. For those who are successful short traders this provides an excellent opportunity for a big payday.
The longer term chart of Google (now Alphabet) has some interesting activity of late and I thought blogging about what is setting up may be an interesting example to learn from. The current price movement has formed a triangle pattern and rests right on its lower support line. Because triangles can break higher or lower with no edge to up or down, the investor is best to wait for confirmation and hold before entering any position. One other important piece of evidence we cannot ignore is the fact we have negative RSI momentum divergence. This gives the slight edge the eventual break will be to the downside.
You can see this is the second triangle that formed as one sits directly below the current pattern. This triangle was textbook as price broke out with above average volume and moved strongly higher and slightly exceeded its upside target before putting in a 15% correction. Notice how, at that time, RSI momentum was near the midline and with no divergence. The edge given to an upside breakout.
What happens if I add another triangle, turn it around and put it back to back with the upper one? You get (a sloppy) diamond pattern.
The diamond pattern is a rally to a new high and weakness to an intermediate support level, a second rally to a higher high and a sharp decline through support, followed by a modest third rally and a decline through longer-term trend. Because diamonds are very large patterns, the technical implications are often extremely large.
The diamond formation reversal pattern is found relatively infrequently. When it does form, however, it usually does so at market tops rather than at bottoms. This is consistent with its appearance, which suggests a confused, active market found at a top more often than at a bottom. As the figure shows, the diamond starts off as a broadening formation and then consolidates, usually forming a symmetrical triangle. The combination of price patterns first broadening and then consolidating gives the geometry for which the diamond is named. This shape becomes more apparent when trendlines, like those shown, are drawn connecting successive peaks and valleys. The shape has also been described as a complex head and shoulders with an odd center movement.
One critical thing investors who use patterns need to do is to insure they do not jump the gun. Do not invest before the pattern has completed. Just because a pattern is developing and acting ideally does not mean it will finish that way. As such, it is imperative to wait for confirmation which is, in this case, a break out from either side of the blue trendlines. For the diamond pattern your odds of success increases as 1) breakout occurs closer to apex and 2) the number of touches price makes on the trendlines increase.
While this is an excellent example if we circle back around to see what eventually happens, the ramification of Google breaking out (to either side) of this pattern has significant consequences due to is importance and contribution to the indexes. A breakdown suggests we are in for another correction and a retest of the February lows. A breakout to the upside suggests we are off to new highs and the next leg of the bull market in US stocks has begun.
Stay tuned it should be exciting either way.
