Written by and copyright © 2005-2018 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners.

Headlines

• Wednesday, 12/31/2008. Pennant Flies in ABC!
• Tuesday, 12/30/2008. Tutorial Tuesday: Drawing Three Point Channels.
• Monday, 12/29/2008. A New Direction: The S and P 500 Index.
• Wednesday, 12/24/2008. Complex Head-and-Shoulders Bottom in Brazil.
• Tuesday, 12/23/2008. Tutorial Tuesday: Ugly Patterns Rule! Find Out Why
• Monday, 12/22/2008. Focus on Fundamentals
• Thursday, 12/18/2008. An Oil Play?
• Wednesday, 12/17/2008. Time to Buy Gold Again?
• Tuesday, 12/16/2008. A Flooding Tale.
• Monday, 12/15/2008. New Target for Wilshire.
• Thursday, 12/11/2008. Investing in Obama Cement
• Wednesday, 12/10/2008. HEV: The Abandoned Trade
• Tuesday, 12/9/2008. Tutorial Tuesday: Predicting Trend Changes using Triangles.
• Monday, 12/8/2008. Market Retrace and Takuri Lines.
• Thursday, 12/4/2008. Tutorial Thursday: DCB Industries.
• Wednesday, 12/3/2008. Rounding Bottom in Natural Gas?
• Tuesday, 12/2/2008. Down Market and House Flooding.
• Monday, 12/1/2008. General Announcements, Portfolio Change.

Wednesday, 12/31/2008. Pennant Flies in ABC!

No blog tomorrow due to the New Year’s day holiday. Facing blog withdrawal symptoms? Monday I will discuss a trade in CHG, one of the utility stocks I own unless something else intrudes. Patterns for the weekend will appear on Friday, so you can spend all weekend getting prepared.

The chart pattern indicator has flipped to bullish, but it could flip back to bearish within the next week or so.

On websites, in books, and in magazines, writers seem to classify any consolidation region as being a flag or pennant. Like any other chart pattern, flags and pennants have a definite shape with identification guidelines that separate them from other patterns. Let ’s take a look at pennants today.

A pennant is a triangular shaped object perched atop a flagpole. See the inset in the chart of AmerisourceBergen Corp (ABC). The flagpole is a straight line run leading to the pennant, often several points in duration, but usually lasting just a few days. Atop the pole comes a consolidation phase -- the actual flag or pennant. A flag has price action following two parallel lines, but with the pennant, the trendlines converge (narrow to a point) like that shown in red.

If you don’t have a flagpole, then you don’t have a flag or pennant.

Also, the flag or pennant can tilt in any direction, up, down, or sideways. The one shown in the figure is sideways (has no tilt at all). Figures at the above links illustrate the different varieties.

Flags and pennants are short patterns, lasting no more than 3 weeks or so. This is an arbitrary guideline, but anything longer is better classified as another chart pattern such as a symmetrical triangle, rectangle, or channel. Finally, volume usually trends downward in the flag or pennant portion of the chart pattern. Do not exclude a flag or pennant just because volume trends upward or has an irregular shape.

Looking at the numbers from my book, Encyclopedia of Chart Patterns, 61% of pennants in bull and bear markets breakout upward, but only 52% in a bear market show an upward breakout. Since this is a bear market, the breakout direction is about random. A breakout occurs when price closes outside of the red trendlines, or for an upward breakout, a close above the top of the flagpole (the highest high in the pattern). A buy order a penny or two above the highest high will get you in at the right price. After an upward breakout, should price close below the pennant (consolidation or support region), then close out the trade.

In well behave flags and pennants, the chart pattern appears midway to the ultimate price move, so they are classified as half staff patterns -- like a flag lowered halfway down the pole when someone important dies.

I show the pennant in ABC because it looks so pretty. The flagpole is a straight line run up and bursting out of a consolidation region. The pennant is nicely shaped.

Brooks Automation (BRKS) also shows a pennant pattern atop a long flagpole.

-- Thomas Bulkowski

Tuesday, 12/30/2008. Tutorial Tuesday: Drawing Three Point Channels.

Erik asked about the following paragraph from my book, Getting Started in Chart Patterns, page 29.

"When price pierces a downsloping trendline and makes a higher peak (note: this is the second, higher peak), connect the two peaks with an upsloping trendline. Then draw a new line parallel to the original trendline starting at the low between the two peaks. The lower trendline shows where price is likely to reverse."

I call this a three point channel.

Let us apply the technique to the Dow industrials (^DJI), which I show on the daily chart.

I drew a blue trendline along the peaks. Peak A appears, piercing the down-sloping trendline. Then price reverses to form a bottom at C followed by a second peak, higher than A at B. If you draw a line connecting A and B, you get an up-sloping trendline. This outlines the new direction price is expected to take.

Draw another line connecting valley C and parallel to the A-B line. This new line, which I show as line C-D, except extended into the future, forms the bottom of a channel. Price is expected to touch the bottom of the channel, and it does at D, reversing there.

This technique of drawing a channel with only three points, A, B, , and C works when the new price action follows a trend, which is rare. Although it does not always work, it can give you a jump on where price is expected to turn.

Three point channels also work for up-sloping trends, too. Reference the ideal situation as depicted in the chart.

1. Draw an up-sloping trendline along the valleys which I show as line D-E.
2. Look for price to pierce the trendline, moving lower and forming a valley at A.
3. Price recovers and forms a peak at C.
4. Price drops to a new low at B, below A.
5. Draw a line parallel to trendline A-B, touching peak C.

The next bounce upward may touch the top channel trendline if all goes according to plan. Adjust the trendlines as future price movement dictates.

-- Thomas Bulkowski

Monday, 12/29/2008. A New Direction: The S and P 500 Index.

I show a chart of the S&P 500 index on the daily scale. A top red line connects peaks A, B, and C, forming a down-sloping trendline. Another red trendline connecting valleys D and E highlight a loose-looking support region. Price cuts through the bottom trendline in a false breakout from the descending triangle.

Descending triangles breakout downward 64% of the time, according to my statistics on over 1,150 of them. But the breakout has already happened in the late November plunge.

I drew another trendline parallel to the A-B-C trendline in green connecting the valley before E, E, and F.

The descending triangle can break out in any direction, and if it does breakout lower, the index could follow the green and red channel downward.

As I write this on Saturday 12/27, the chart pattern indicator has been bearish for 5 days now, close to the 7 needed for a reliable signal. My guess is the bear signal will stick, and that means more down coming. The indicator also shows bearish divergence between the indicator and the index, suggesting continued weakness.

Anything could happen in the new year and with Obama taking office in late January, that could cause more Americans to feel good about themselves and the economy. And that might cause the market to turn bullish.

-- Thomas Bulkowski

Wednesday, 12/24/2008. Complex Head-and-Shoulders Bottom in Brazil.

There will be no posting on December 25, which many recognize as Christmas. I will spend the day working on fundamental analysis in the morning, my website in the afternoon, and then slaving to cook my dinner.

Many of the short ETFs were ex-dividend today, so prices dropped dramatically. Uri Scharf brought that to my attention via email. Thanks Uri!

The chart shows a picture of the MSCI Brazil index fund (EWZ), on the daily scale. LS is the left shoulder, RS is the right shoulder of a complex head-and-shoulders bottom. If you can find a normal head-and-shoulders bottom, then look to the sides of the pattern for additional shoulders.

A near-horizontal neckline is often another clue to a complex head-and-shoulders bottom. In this example, the neckline has a steep slope but that’s ok. Another neckline appears associated with the inner head-and-shoulders bottom as a green line.

A complex head-and-shoulders bottom can have multiple heads, multiple shoulders, or both. Look for symmetry between the left shoulders and the right ones. They should be spaced the same from side to side and bottom near the same price as their mirror opposite.

Since the complex head-and-shoulders bottom is a bullish reversal pattern, does that mean the index fund (an exchange traded fund) is about to turn around? That is certainly possible, but my guess is the economy of the world is in such poor shape that the fund will continue to decline, busting the complex head-and-shoulders bottom and leading to a loss for anyone that bought it.

This is not the only complex head-and-shoulders bottom that I have seen in an ETF. Australia shows one (EWA), Hong Kong (EWH) -- two heads, Pacitic ex-Japan fund (EPP), Global materials (MXI), and Broker-dealers (IAI).

Have a safe and happy holiday. And if your relatives start bugging you, tell them not to upset you because you’re running out of places to hide the bodies.

-- Thomas Bulkowski

Tuesday, 12/23/2008. Tutorial Tuesday: Ugly Patterns Rule! Find Out Why

The following is taken from a study I did on ugly chart patterns.

I looked at double bottoms and double tops to determine whether ugly (uneven) tops or bottoms performed better than those with even peaks or valleys. Here’s what I found.

Numbers in parentheses are samples used in the test and the percentages are the average move post breakout. Double bottoms have the most samples. When the valleys are within 0 to 1% in price from each other, the rise averages 31.5%. When the valleys are 4 to 5% apart in price, the rise averages 42.8%. Thus, the uglier the chart pattern, the better the performance.

I have also noticed the reverse: The more perfect the pattern, the more likely it is to be a dud. I see this often in head-and-shoulders bottoms but I do not have statistics to back up the claim.

-- Thomas Bulkowski

Monday, 12/22/2008. Focus on Fundamentals

One of the questions I am asked often, is how do I select stocks when building a portfolio? The FAQ provides one answer, but I wanted to look at fundamental analysis today.

When selecting stocks to build a portfolio, if you pick stocks with good fundamentals, you give yourself a built-in edge because they tend to outperform stocks with poor fundamentals. But what fundamentals lead to the best performance?

On the Fundamentals page, I provide answers using numbers from Value Line (often available for free at large libraries). Here is a partial review of what I found.

• Price to book value.

Book value is what a company is worth. Many games can be played with book value by either inflating the value of assets or undervaluing them. Peter Lynch recounts a tale in his book, One Up on Wall Street by John Rothchild, that Warren Buffet had hoped to get $866,000 for the book value of machinery from a textile plant they were closing down. They bought the machines for $5,000 a few years earlier but received only $26 each. The $866,000 book value turned into $163,000.

Price to book value can tell you whether or not you are overpaying for a stock. A low ratio is good. Testing reveals that stocks with a low price to book ratio tend to outperform those with a high ratio 78% of the time.

• Price to cash flow.

Analysts love cash flow, especially free cash flow. Free cash flow is what remains after removing capital spending (reinvesting in the company to build plants and buy equipment). I found that stocks with a low price to cash flow outperformed those with a high ratio 78% of the time. A low ratio means the cash flow is high relative to a stock’s price.

• Price to earnings.

Many know what the p/e ratio means: it is price divided by earnings. The lower the ratio, the better. A low p/e means earnings are high compared to the price of the stock. A low p/e is especially good if it is half the growth rate for the company, and bad if it is twice the growth rate, according to Lynch. As in many of the ratios, you will want to compare the p/e for a company against the ratios of other companies in the same industry. That will tell you at a quick glance, which companies are over, under or fairly valued. My testing showed that companies with a low p/e ratio outperformed those with a high one 71% of the time.

• Price to sales.

You may not have heard of the psr (price to sales ratio). I remember reading Forbes magazine in the late 70s when psr was in vogue, how values below 1.0 meant a good value. Testing shows that they were right, and companies with a low ratio outperform those with a high one 71% of the time.

• No dividends.

I found that stocks without a dividend outperformed those with dividends 80% of the time. Having said that, a significant portion of my portfolio is in utility or other stocks that pay a hefty dividend.

Stocks that keep their cash instead of paying a dividend reinvest the money in the company. That reinvestment often leads to a higher stock price when the value of the company rises. For people that enjoy current income, a dividend paying stock sure beats what you can earn at a bank, especially since the government cut interest rates. Just watch how little your money market fund will yield.

Imagine if I told you about a company with a safe dividend that yielded 8%. Would you be interested in owning it? I have purchased stocks this past year for just that reason. Thus, a stock paying a high dividend offers downside protection. If the stock drops too far, the yield will go up and that is attractive to people hunting for income. Just be sure that the dividend is safe. That means the company is earning more than they are paying out as dividends.

Back in October, I listed utility stocks and their payout ratio (the percentage of earnings paid as a dividend), in case you are interested.

Also, be wary of a stock that pays too high a dividend. It might be cut and if that happens, those investors owning the stock for the income will dump the turkey.

If you hunt for companies with values for the fundamentals as described above and then use technical analysis to time your entry and exit, you can make a lot of money. Buying a value play gives you an extra cushion as you trade the stock.

-- Thomas Bulkowski

Thursday, 12/18/2008. An Oil Play?

The chart of Sunoco (SUN) appears on the daily scale. Outlined in red is an ascending triangle. Having a buy stop a penny above the top trendline would have scored today since the stock gained 5.75%. It is up on an upgrade by Soleil from hold to buy. On Friday, another analyst increased his Q4 view of earnings, but noted that gasoline margins would be pinched. He had a $38 target on the stock, but it closed today over 41. S&P raised their $37 twelve month target to $40. Notice how close the targets are to the current price (even at the time of issuance, the targets have been unusually close, as if everyone knows this is not going to double in the future).

Have you filled up at the pump recently? The price of oil has been dropping and Sunoco refines it. With the price of oil and gasoline coming down, any product held in inventory would fetch a lower price than what it was purchased or refined at. So, yes, margins are narrowing. OPEC today announced a 2.2 million barrel cut in production, its largest cut ever, but the price of oil still dropped. Other non-OPEC oil producers are also cutting production (or threatening to).

If you look at published brokerage reports, they are positive on the company despite the falling price of oil. As a value play, this is a good stock to own because the five ratios that Ford highlights are pegged at the bottom of their channels.

If you look at a longer term chart, you will see lots of overhead resistance, so any up move will likely have difficulty rising to the top of the chart. In this market, however, anything can happen. If OPEC and non-OPEC members can deliver on their production cuts and the world keeps guzzling gas, then maybe there might be a play here.

I am not sold. I think the stock will round over in a throwback and perhaps collapse from there. If the price of oil keeps dropping as many believe will happen, the price of gas and refining margins will also drop. That will not be good for the company. I have seen price after an ascending triangle rise by 5% to 10% and then plummet, leaving owners of the stock with another loser. Thus, I tend to avoid trading ascending triangles. Although the technical aspect of this situation looks good on the surface, I am going to avoid buying into it. Perhaps a few weeks will give clarity to the picture.

-- Thomas Bulkowski

Wednesday, 12/17/2008. Time to Buy Gold Again?

My flooded neighbors called the insurance company which dispatched an emergency response team (that is, hired a company that specializes in fire and water emergencies). The team found that the water had wicked up the walls 28 inches (meaning it soaked them that high, but the water was not that deep).

They ripped out the carpets, placed fans, dehumidifiers, and broke an antique vase in the process. No signs of mold yet, probably due to the cold weather.

I began to release findings on fundamental analysis, beginning with the P/E ratio. The preliminary results show that picking low P/E stocks would beat high P/E stocks 71% of the time.

The chart shows GLD, an exchange traded fund on the daily scale, forming an Adam & Adam double bottom at A and B. The chart pattern confirmed when price closed above the green horizontal confirmation line. Price threw back to the breakout price and dropped a bit more at C before recovering.

If you have been looking at my trading setups, you will know that when price drops below the confirmation line during a throwback, it represents a weaker breakout than if price were to remain above the line. Based on that finding alone, this is not an especially strong breakout.

Having said that, I drew a blue trendline along the peaks. Gold might reverse there. With the dollar falling, however, that could force GLD to continue moving higher. Based on the chart, with nearby overhead resistance, now is not the time to buy gold.

-- Thomas Bulkowski

Tuesday, 12/16/2008. A Flooding Tale.

I would like to thank Kardaya Rooprai for beginning the tedious chore of supplying me with historical intraday price data. It will allow me to test numerous day trading scenarios and setups. Thanks, Kardaya!

# # #

What do you do when your neighbor’s house is on fire? Bring marshmallows so you can toast them, of course. So when my neighbor’s house flooded from a broken coupling underneath the sink, I brought two bottles of wine. While they worked mopping up, I sat back, drank, and had fun watching them slosh around!

Here’s the real story. They were away (and you are always away when bad things happen), when the coupling that joined two copper pipes underneath their sink gave way. When the water began rolling down the street, their neighbor noticed it and called them, only their cell phone was off. Oops. He also called the city and the town turned off the water leading to the house. That was Friday. The couple turned on their cell phone on Sunday and got the message, then raced back to their house.

What they found was the downstairs flooded. It looked fine until you stepped on the rug and your feet sloshed.

That was when I got involved. They called me to ask if they could return a cage I lent them to hold their dying dog (a Westie has cushings disease) and she remarked about what had happened. Since I was dying to try out my new wet vacuum, I offered to help and/or to let them use it. Hubby took the vac and stopped in at the local grocery store and also rented a carpet shampooer machine.

When I finished eating dinner, I walk the thee streets to their house and looked in on them. She was nearly in tears and he was busy sucking up the water with the shampooer. My wet vac remained untouched. So I went to work, grabbed the vac, and started sucking. Another run to my house brought back 5 box fans, a mop, and those two bottles of wine (Berringer’s Moscato -- a white wine that is fruity and sweet. Yum!).

Four hours later, they were ready to call it a night. The wine was gone, much of the water was, too. Of course, the carpets were still soaked with furniture resting on it. But the shampooer worked well sucking up the water from the carpet. Thus, if you ever have a water accident, rent one of those things and go to work. My vac also sucked, if you can call it that. I pulled up several 8 gallon bucket full’s of water from the carpet. My wet vac did a good job but it was just too small to do the whole house. The shampooer worked better, but filled quickly because it only contains a gallon or two of water before you have to empty it.

The moral of the story is this: If you ever leave your house for an extended time, turn off the water. You might also want to power down as much as possible, too (like the water heater).

Checking on them this morning, their water heater relief value busted, too. Water was being pumped out of the overflow tube all night long. Hubby was in the process of replacing the valve. The kicker is, this is the time of year when the city gauges water consumption to set sewer rates (an average of 3 months). With the kind of water usage they have experienced, the bill will be enormous. Of course the city will work with them, I think, because they did when another neighbor filled a swimming pool in December and nearly had a coronary when he got the bill.

# # #

After shaving with an electric razor each morning, I clean it by prying off the top of the shaver and blowing out the whiskers over the toilet. Plunk! I dropped the blades into the toilet bowl. Faced with plunging my hand into the toilet water, I stood up and said, "Time to sell the house!"

-- Thomas Bulkowski

Monday, 12/15/2008. New Target for Wilshire.

Question: How much did my doctor (physician’s assistant, really) charge to check my swollen lymph nodes, tell me there was nothing to worry about, and to flush the ear wax out of my ears? The answer is at the end of this blog entry.

Like many of you, I have been scratching my head over market direction. Things are so negative now and yet the market has been rising. When a bear market begins ignoring bad news and rising like a child’s balloon untethered, then it could mean the start of a bull market. Or a sucker’s rally.

If you look at the top of this page and click on a number in Tom’s Targets, you will see an explanation for the target. I made my prior guesses on 11/23 when the market was tumbling. The obvious choice was to conclude that the market would continue dropping. It didn’t. New targets are now there, as of 12/11/08.

What do I see happening now? For the Wilshire 5000, I show a picture of what I think will happen to the index on the daily scale.

Price often moves in mirrors -- reflections across some arbitrary vertical line. I show my guess with a green line. Price movement to the right of that line is what I believe will happen.

I see the index peaking and then declining back to a low of about 8,400. That is a round number and it bottoms at the valleys shown in the descending triangle highlighted by red lines. The 8,400 target also corresponds to a 38% Fibonacci retrace of the move up from the November 21 low at 7340.

Just keep in mind that I don’t know everything. My targets are just guesses.

And the PA charged me $280. That’s $115 for the visit, $105 to flush the ears, and $60 for supplies. The supplies amounted to several drops of hydrogen peroxide and a syringe to squirt it into my ears. They also had to clean a little tub that collected the flushed material -- all of which you can buy at Walmart for less than $10. Wow. It’s like they triple the prices knowing that insurance will pay half, which it did. Life sucks and then you die. Unless you believe in reincarnation, in which case life sucks, life sucks, life sucks... Eat right and get plenty of exercise so you can die healthy.

-- Thomas Bulkowski

Thursday, 12/11/2008. Investing in Obama Cement.

Good news! My new smoke detector works. I found that out when preheating my oven to bake muffins. The last time I used the oven, I made lasagna and the drippings were caught by the aluminum foil pan that you can buy for a few bucks. I had to open the windows to air out the place. I know it is not winter yet, but it sure felt like it was snowing...inside.

I spent today looking at my database of nearly 635 securities, hunting for buying opportunities, then I remembered that Obama wants to spend bucks on infrastructure. What industries will benefit? Answer: Steel and cement. Since I don’t track steel, I looked at cement. Let me discuss them.

Cemex (CX) is a foreign company, so they may have a more difficult time profiting from Obama cement. Same with CRH plc (CRH).

Martin Marietta Materials (MLM) has already made its move off the bottom and is much too expensive at this point. The company derives about half of aggregate revenue from public works projects, but aggregates represent 92% of net sales and profits in 2007. No doubt that has been factored into the price. The other half goes to residential and non-residential construction. S&P has a sell on the company. Ford Equity Research has a hold but notes that performance is expected to be below average over the next one to three months. The stock closed today at 98.35 and it could recover to its old high at 170. I believe this stock has already made its move and that suggests the others have, too.

Texas Industries (TXI) looked good, but the recovery potential is not as high as others. Plus, Ford Equity Research rates it a sell based on many factors including decelerating earnings growth (no surprise), negative analyst forecasts, poor price momentum in the coming one to three months.

I like the company and it might do well. The company website says it operates primarily in Texas and California and is the largest, lowest cost supplier of cement in Texas and will be the second largest, lowest cost supplier in California. It recently finished modernizing its Southern California cement plant. It is not known what the breakdown between its three business segments are (cement, aggregates, and consumer products). The stock is a good value at about 20 because there is a large support zone going back to 1988. It closed today at 35.06 with overhead resistance at 45. That (45) would be my near term target. so there is diminished upside in the stock.

U.S. Concrete (RMIX) is near death’s door, based on its low price. Ford has a sell on the stock and S&P has a C rating (lousy). From the description on yahoo, it seems as if the company can profit from Obama’s plan of infrastructure spending. The company expects to lose money this year. The stock closed today (Wednesday) at 3.38. On the weekly chart, the stock could recover to overhead resistance at 5 if it can plow through resistance starting at 4.

Vulcan Materials (VMC) shows price closing at 69.93 with a recent low of about 40. It has climbed fast in a straight-line run up since the low on 11/21 and it looks to be overpriced now. S&P has a sell on the company with a 1-year target of 48. Ford has a strong sell on the company. Based on its high price, this is a situation to avoid.

I show the chart of Eagle Materials (EXP) and it is not a tight pattern that I like to see, but a rather loose looking turn at the head-and-shoulders bottom. The move down from 34 on the far left is a measured move down with the corrective phase in the middle of the chart, followed by the second leg down from 32 to 14.

In an MMD, price often retraces back into the corrective phase, which is what happened. I show the corrective phase as the area marked by two green lines. Let me also say that the beginning of the MMD was at a high of 37 on June 4. If you look at a longer term chart (not shown), you will see overhead resistance at about 35. That would be my ultimate price target. By that, I mean a few years from now, I would expect the stock to claw its way up to 35 and then run into trouble. Of course, it would have to burn through the corrective phase of the MMD first and that will take some doing.

Notice the up-sloping blue neckline, and notice that price may not touch it. That is why I use the red line (from the right shoulder peak, drawn horizontally) as the buy signal. However, I am not saying buy the stock at this price.

This company makes gypsum wallboard which is in oversupply from what I have read. That is no surprise given the sate of the residential industry.

If the infrastructure projects gear up, then demand for cement and aggregates will grow. The stock should prosper but will not reach its full potential until the real estate market firms up and there is no telling how many years that will take. Nevertheless, I expect this stock to move from 20 to 35 in 2 years or less. That time period is a guess, of course. Along the way, look for price to stall at 24-26 then 27-28 and 30-31 before making a sprint to 35.

Downside would be a drop of ~10% to 18.18 based on today’s close of 20.42. The ~10% loss is an arbitrary stop level but one that would put it slightly below the October gap where it might find support. Volatility is quite high for the stock. My computer says not to put a stop closer than 16.16, which is 21% below the close. Ouch! That is too far away and it suggests that you avoid the stock.

EXP is a mediocre play. With such high volatility, it is a risky setup, especially since their wallboard operations are sucking wind and will continue to do poorly in the future.

If price drops in some of these stocks, they might be good picks for a long-term holding period. In the near term, it appears that they have already made their move.

-- Thomas Bulkowski

Wednesday, 12/10/2008. HEV: The Abandoned Trade

When I saw the chart of Ener1 (HEV) on the daily scale, I was excited! Why?

The chart says it all. Look at how the stock has performed during this bear market downturn.

The chart shows the stock rising from $5 to almost $10 on Monday. The 52 week price change, according to yahoo!finance, is +258% compared to the drop in the S&P of almost 40%. The stock even has a negative beta (-0.18). That means it tends to move opposite the market -- which is a good thing in this bearish environment.

The chart shows the stock breaking above the red trendline in a strong push on Monday. Today (Tuesday), the stock sank almost 6% to close at 8.85, which is still above the trendline.

Why does the stock have such support? It makes lithium ion batteries for hybrid electric vehicles, fuel cells, and is working on nanotechnology. Their website says that "Ener1 is currently in conversation with a significant number of automotive OEMs and Tier 1 suppliers, and has publicly stated it will seek to sign two additional development contracts by the end of 2008." Of course, they are running out of time on that.

Since websites are sometimes the last to be updated, a check of the news headlines shows no contracts of note. Once will cost the company money to "test EnerDel's [a subsidiary] multiple hybrid electric vehicle (HEV) battery chemistries under real world conditions" according to yahoo.

With the new administration focusing on alternative energy for automobiles, it would seem that this company has a promising future. Indeed it does, providing the auto companies and those tier 1 suppliers don’t go belly-up first.

What bothers me is the fundamentals.

A look at the key statistics page on yahoo says that the price to sales ratio is 1,475.93. A value below 1.0 is considered good -- the lower the better. The huge number for the company says that sales are tiny. In fact, revenue is just $686,000 and the company lost money for the last 2 years.

Ford Investment Research has a sell rating on the company due to its weak financial condition and large price run-up. Over the coming 3 months, it says the stock is likely to underperform. It has $18.65 million in cash, but that is probably an old number. I don’t know how fast it is burning through its cash. Total cash flow from operating activities was ($26,692,000) in December 2007, up from ($17,126,000) in December 2006. The company appears to be financing its operation through stock sales to the tune of $47 million in 2007.

In other words, the company is bleeding. Perhaps those contracts will pump in new cash to support the R&D activities that are eating up the cash. My guess is additional stock offerings will be made and that will not be good for the stock (think dilution of earnings per share ratio).

Despite the future promise of this company as being one of the few (perhaps the only one) US suppliers of lithium ion batteries for hybrid electric vehicles, the financials are too scary to contemplate an investment in this company...at least for me. The technicals say buy, but the fundamentals say sell.

-- Thomas Bulkowski

Tuesday, 12/9/2008. Tutorial Tuesday: Predicting Trend Changes using Triangles.

In the book, Elliott Wave Principle , authors Frost and Prechter write that the market often turns when price reaches the apex of a triangle. I tested this using three methods and found it to be true in all cases. Price reaches a minor high or minor low 75% of the time within a few days of the triangle apex. Price turns from down to up or up to down 60% of the time.

The chart shows a symmetrical triangle on the daily scale. If you draw the two trendlines carefully along the tops and bottoms of the pattern, they converge at the triangle apex sometime into the future. Where they join, expect price to turn there.

In this example, the triangle apex is at A and the market turns at B. Clearly the turn is not a lasting one, but price drops by 8%. It is not a trend change so much as it is a pause in the upward price trend.

I tested this behavior in ascending, descending, and symmetrical triangles. Read the link for more information about this behavior and then remember it when trading. Sometimes this can save you money.

-- Thomas Bulkowski

Monday, 12/8/2008. Market Retrace and Takuri Lines.

The top of this page shows how far the indices have dropped, but how much of the prior up move have they retraced and why do we care? Let’s take the second half first.

When price moves up, it often retraces a portion of that move, meaning it drops part way down before resuming another uphill run. If we measure how far down the hill price has dropped, we can see if it matches one of the Fibonacci retrace values that often mark support zones or turning points. If price is near a Fib retrace value, especially 61.8%, then price could find support and even turn higher. I have used the 61.8% Fib retrace level to enter swing trades.

If price drops below one Fib retrace value, you can guess that it is going to drop to the next lower one.

The following table shows the percentage retrace of the uphill run starting from the low at the last bear market, generally in late 2002, to the highest high in 2008.

Let’s take an example, using the Russell 2000 on the monthly scale. At A, price reaches a low of 324.90 then moves up to a high of 856.48 at B, followed by a retrace of the up-move with a plunge to C, at 371.30. Using the formula shown in the chart, we have (856.48 - 371.30)/(856.48 - 324.90) or 91%.

Common Fib retrace turns are at 38%, 50% and 62%. Some consider 75% to be another turning point, but if price drops below 62%, I consider the possibility of a retrace as exhausted. Conceivably, you could continue to subdivide the numbers into more and more levels, eventually finding one that hits your retrace value. To me, that sounds like curve fitting -- making the numbers fit the situation.

I did a study that showed the top five turning points as 61%, 56%, 50%, 55% and a tie between 44% and 59%. Price blew through the 38% Fib retrace value, so it did not appear in my results, but the 61.8% (61% is close) and 50% Fib retrace values are dead on. If you use a retrace value of 66%, price will turn before that point 67% of the time.

Returning to the table, the only market index close to a Fib level is the Dow utilities. If you have read this blog, you will know that I am a fan of the utility companies because you can collect a dividend as they head toward zero like all the other stocks. In a bear market, you will still lose your shirt, but the sunburn doesn’t hurt as much.

The chart also highlights a Takuri line candlestick in the most recent price bar. Since this is on the monthly scale, it represents the price action of the first week in December.

Flipping open my Encyclopedia of Candlestick Charts book (pictured on the left) to hammers, it says to look for a hammer with a lower shadow two to three times as tall as the body. Clearly the shadow is much taller than 3 times the body height, so this is better classified as a Takuri line. Takuri lines appear in a downward price trend and the body can be any color. The lower shadow should be at least 3 times the body height with no or a very small upper shadow.

The Takuri line acts as a bullish reversal 63% of the time in a bear market, ranking 21st out of 103 candle patterns for reversal performance, where 1 is best. The frequency rank is 28th, so you can find them often. In fact, all of the major market indices show either hammers or Takuri lines (depending on whether or not you have your reading glasses on). However, the overall price trend after a Takuri line breaks out ranks 47th, which is mid list. That means the average move sampled over 10 days after a close above the top of the candlestick is not exciting.

A check of the performance numbers shows that this candle performs best when the breakout is downward in a bear market. After 10 days, price dropped an average of 4.45%. That is well short of the 6% or higher moves I like to see, so you can see the weakness that this candle exhibits.

If you use the candle height as a targeting mechanism and add the height to the price of an upward breakout, you will find that this "measure rule" works 80% of the time. Thus, I suggest you multiply the height (high to low range) by 80% before adding it to the breakout price (top of the candle). Downward breakouts in a bear market work 79% of the time, and the measure rule applies the same way, using the candle’s low as the breakout price, projected downward.

Putting this into numbers, we find that the upward target would be High + 80% x (High - Low) or 466.54 + 80% x (466.54 - 415.99) for a target of 506.98. The downward target would be 376.06.

You can just look at the chart to guess where the targets reside. The lower target is just above the low at C and the upward target is well into the body of the November candlestick. Being able to make these kinds of price projections is why I find my two Encyclopedia books so helpful. Both cover the measure rule.

-- Thomas Bulkowski

Thursday, 12/4/2008. Tutorial Thursday: DCB Industries.

According to yahoo!finance, ProShares has released new exchange traded funds that track gold and silver at twice the volatility of the underlying, from both the long and short side. Check out UGL (long gold), GLL (short gold), AGQ (long silver), ZSL (short silver).

On Monday, I wrote that the downturn had returned to the markets but yesterday and today (Tuesday and Wednesday) have been up days. Wait until Friday! That is when important economic reports come out and my guess is the market will tumble. If not, then it could mean that bad news does not effect the market any longer. It would be a sign of a bottom, so stay tuned.

Yesterday afternoon, I received an email from Mike Siewruk at Market Traders Radio in Detroit, asking if I would do a radio interview. Since I just completed Gabriel Wisdom’s show, how could I turn this one down? So I said yes. "How about tomorrow morning at 10 EST?" Wow. That meant I had just a few hours to write yesterday’s blog, eat, and prepare.

By the time I went to bed at 11 pm, I felt good about being ready for the show, but I knew the night would be a difficult one. I took a sleep aid and that knocked me out until 4 am when I woke and started stressing about the interview. What would I say? Did I have all of the questions covered?

I could not fall back asleep. I felt as if I was being served as the main course to a bunch of cannibals.

Yes, I’m a wuss.

The show, which will be broadcast on Saturday, was one of the better ones that I have done. Both Mike Siewruk and his partner Jack McPherson did a wonderful job at keeping the conversation flowing. For my part, I tried to explain trading setups and such as best I could without using my hands or drawing pictures (think radio).

# # #

Which industries dead-cat bounce the most? A dead-cat bounce is the name for an event pattern where price drops by 15% to over 70% in one session. Bad earnings surprises account for many of the drops as do news of failed drug trials. Here is the list of industries that have the most and fewest dead-cat bounces. When selecting a stock to trade, try to pick from an industry that has few dead-cat bounces.

Top 10 Industries

These have the fewest dead-cat bounces. Note that this list is somewhat dated because the homebuilding industry is top ranked. It has numerous large drops when people stopped buying homes, so the order has probably changed. For a complete list of the industries I follow, click here.

<Rank><Industry><Raw score>

1. Homebuilding: 0.0000 (Tied for best)
1. Metals & Mining (Div.): 0.0000 (Tied for best)
2. Water Utility: 0.7013
3. Oilfield Svcs/Equipment: 0.7912
4. Petroleum (Producing): 0.8013
5. Insurance (Prop/Casualty): 1.2495
6. Chemical (Diversified): 1.5026
7. Petroleum (Integrated): 1.5291
8. Electric Utility (East): 1.5297
9. Food Processing: 1.6453

Worst 10 Industries

These industries have the most dead-cat bounces.

<Rank><Industry><Raw score>

35. Air Transport: 8.9939
36. Human Resources: 9.3693
37. Medical Supplies: 10.5895
38. Computers & Peripherals: 11.2197
39. Semiconductor Cap Equip.: 11.2601
40. Drug: 11.5676
41. Building Materials: 11.9190
42. Retail (Special Lines): 13.8675
43. Semiconductor: 15.7000
44. Internet: 18.2355 (Worst)

-- Thomas Bulkowski

Wednesday, 12/3/2008. Rounding Bottom in Natural Gas?

The chart shows United States Natural Gas exchange traded fund (UNG) on the daily scale. According to yahoo!finance, the fund "seeks to replicate the performance, net of expenses, of natural gas. The trust will invest in futures contracts on natural gas traded on the NYMEX that is the near month contract to expire."

What I see is a potential rounding bottom chart pattern. Beginning in July, the fund peaked and as the blue line shows, it has trended lower but at a less rapid decline. In other words, it looks as if natural gas is searching for a bottom, making a slow turn along the way.

Does this mean that natural gas is going to trend higher such that the fund will approach the high of nearly 64 in July? No. There are a number of resistance areas it has to penetrate first, none of which are shown on the chart.

The first target would be a rise to the double bottom lows in September and December 2007 followed by another resistance zone near 38 to 40. Given the weak demand for oil and a slowing economy, natural gas demand will also likely remain soft. Thus, the fund may move horizontally for a while then climb to about 40. That matches a 38% Fibonacci retrace of the down move since July, and that would be my guess.

As with some rounding bottoms, look for a quick run up midway through the turn. After the rise ends, price often returns to almost the launch price. Thus, do not get too excited if natural gas spikes. Take profits at the top, if you can, and you will likely be able to buy back in at a lower price a few weeks later. The small figure to the right shows an ideal example of this move.

-- Thomas Bulkowski

Tuesday, 12/2/2008. Down Market and House Flooding

Last Wednesday I bought the DOGs exchange traded fund, so I have been waiting for the market to tumble. The DOG shorts the market, so having the market drop is good for the etf, but bad for my long term holdings. This week will likely continue the bear market because economic reports are due, and they are likely to be lousy. Thus, put up your shields, Scotty, and take evasive action.

The chart pattern indicator that turned bullish on 11/20 has flipped to bearish as of Friday. That bearish signal was received today (Monday after the close), due to the lag in the indicator.

I had hoped to discuss sometime of interest for Tutorial Tuesday, but I had a near miss today with my house. Let me tell you about it. I have been building a database of information on fundamental analysis (meaning I've been spending days typing in numbers), working toward a new book that will be years in the making. Anyway, the downstairs smoke detector went off. My dog was hot on my heels as I bounded down the stairs and skidded into the kitchen to find water on the floor and the smell of burnt electrical wiring in the air.

I was doing my wash at the time so I knew where the problem was. To save electricity, I hang my wash outside, so the dryer was unused. That meant it was the washer.

The washer was in the spin cycle so I jumped from dry tile onto the dryer (I didn't want to be electrocuted by trying to turn off the washer while standing in water). I turned off the machine and thought I felt a tingling in my skin but who can be sure?

Only a portion of the kitchen had flooded, but the laundry room was underwater. The hoses leading to the washer were intact and dry. I changed out the rubber ones after hearing horror stories about them breaking and flooding the house while their owners were away at work. I have metal sheathed pvc ones that cost about $10 each. That’s a small price to pay to avoid flooding. The nearby wall was dry, so the water came from the washer...

I spent about 15 minutes using a mop and hang wringing it out to scoop up the water then I thought of a better way. I used a broom to push the water out of the laundry room into the garage. That took just minutes to remove most of the water and the mop did the rest. Fans blowing on the floor soon dried it out. Then I tore the washer apart and ran it though a cycle, setting unchanged, trying to duplicate the problem. The machine worked just fine.

What I think happened is that a solenoid allowing water in got stuck open longer than it should have and it flooded the room (I found water in the mechanism where it should not have been), sending water cascading out of the drum onto the motor. Hence the smell of burnt electrical wiring.

I bought a wet vacuum at Home Depot (cheaper than Lowes) in case any flooding happens again. I have been toying for years about buying one, but it was never a priority nor had a need for the thing. The next time this happens, I will be better prepared.

Here is what I learned today.

• Drying clothes outside takes a long time when it’s cold.
• Airing the house out (removing the smoke smell) is not fun either.
• Replace the rubber hoses with burst resistant ones on your washer.
• Have a wet vac available.
• Never leave running appliances unattended.
• Have smoke detectors that work and check them often.
• Water and electricity don’t mix.

-- Thomas Bulkowski

Monday, 12/1/2008. General Announcements, Portfolio Change.

Pictured is not the Dow Jones industrials but a flower from my garden, of course. I like this shot because the black and blue salvia on the right seems to have a tongue. The flower is all of one inch long, but through the magic of macro photography, it looks like a hippopotamus yawning.

Now that the holiday season is approaching, I would like to remind you that if you purchase anything from Amazon.com, then please do so through this website. Just click on one of the pictures of my books (upper left of page) and that will take you to Amazon automatically with a code passed to them. If you were to buy a book, car, Lear jet, luxury yacht, or other gift, they will pay a small referral fee at no cost to you. That fee helps support this website.

As you know, I do not charge a subscription fee to access over 400 pages of information on ThePatternSite.com, nor do I charge for the Patternz program. Google runs ads and the revenue derived when you click on them also helps defray the costs of running this website. If you see something in an ad that interests you, then click on it and explore what they offer. It may help your trading.

I do not accept compensation of any kind from any third party or company to promote stocks, their stock picks, or products. You can read more on the privacy/disclaimer page. The short version is I do not engage in immoral or illegal activities.

I am writing this on Thanksgiving day (Thursday 11/27) while waiting for my baked beans to ignite the oven. They have been cooking for 6.5 hours so far with 1.5 hours left. Tomorrow I can say that I have gas and I know how to use it.

I hung up my bicycle because it has grown too cold now to ride it. I traveled 1,218 miles on it this year, compared to 341 miles on my car. And those blood suckers at the insurance company charge me almost $1 a mile for car coverage despite no accidents, tickets, or risky behavior.

Those good at math will enjoy this anecdote. I went to Walmart grocery and they had yellow onions for sale: 2 pounds for $2.28 or 3 pounds for $1.50. I found that hard to believe but when I checked out with my onions, the $1.50 was correct. I am considering sending the savings to the government so they can bail out another rich CEO.

Some notes about the test portfolios and industry relative strength: I placed the exchange traded funds into their own industry, one for short and one for long ETFs. The short ETFs hold funds that are short the indices or individual sector. The long ETFs hold only indices. The domestic investment company industry holds long ETFs that do not fit into any industry that I follow, but I still want to track them. The foreign investment company industry holds long ETFs that follow the indices of nations other than the US.

This adjustment may change the performance of the test portfolios. Also, when a stock like Imclone stops trading, it is removed from the portfolio as if the trade never existed. Thus, the portfolio has a problem with "survivorship," meaning the portfolio neither gains a profit nor a loss from the removed stock. I add to and remove stocks from time to time because they are merged out of existence or look as if they are about to go bankrupt.

-- Thomas Bulkowski