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Thursday 1/28/10. Is Down Move Half Over?

Pablo sent me an interesting email today in the form of a question. Are chart patterns in any given stock more reliable than in other stocks? The answer is, of course, I have no idea! But I am going to enjoy finding out.

# # #

I have been working on measured move up chart patterns on the weekly scale in 10-baggers (stocks that rise by 10 times within 5 years), as part of my new book. Every chart I look at, I see only measured moves. And that includes the one to the right.

The theory behind a measured move is that the first leg will equal the second leg. On the chart, that means the move from AB (the first leg down) will approximate the decline of CD (the second leg down) in both price and time. The reality is that the second leg (CD) is longer than the first one (on a dollar basis) between 35% and 39% of the time. On the time scale, the second leg has a longer duration than the first leg about half (53%) the time.

That means if you compute the move from A (the turn at the top) to B (the lowest low found between BC) and subtract that height starting from the highest high found between BC, you will hit the target between 35% and 39% of the time.

The chart shows the Dow industrials on the daily scale. To the right of the red line is what I expect will happen. It's a guess. The horizontal blue line coincides not only with the end of the ABCD measured move down but with support in the form of a prior valley.

The last few days have made me nervous about the rebound that I expected in the markets. I hoped that we would see a more robust jump in price instead of hovering around 0. That tells me the market is going to continue lower. All it needs is a little push from some important company failing to make their whisper number (which is an earnings number that traders expect). If that happens, then the market will likely drop 100 points, maybe more, in one session.

Of course, I could be wrong about all of this. A good earnings report might lift the market, but positive comments from the FED today (Wednesday, as I write this) failed to buoy stocks much (up 42 points). If good news doesn't raise the market, then look out below!

-- Thomas Bulkowski

Tuesday 1/26/10. Tutorial Tuesday: On Partial Rises, Declines, Throwbacks and Pullbacks

The two images are almost self explanatory, but if you need more information, click on the link to partial rises or partial declines.

Traders see these patterns after broadening tops and bottoms, rectangles (tops and bottoms), and even in some triangles. When they occur, they predict the breakout direction. Partial rises predict an immediate downward breakout and a partial decline means an upward breakout.

These two images are of throwbacks and pullbacks. Throwbacks occur after an upward breakout and pullbacks happen after a downward breakout. Just when you think price is going against you, it turns around and resumes the original breakout direction.

If you are a nimble trader, you can place an order to enter a trade at the breakout price and exit within a few days before the pullback or throwback occurs, capturing the initial move before the reversal occurs. In all chart patterns, throwbacks and pullbacks occur 53% and 56% of the time, respectively, based on over 10,000 chart patterns.

The reason I bring up all of this is from an email I received several months ago. I don't remember who sent it, but thanks for the idea. He asked the question, does a throwback or pullback occur more often after a partial decline or partial rise? The short answer is no.

I scanned all rectangles and broadening tops and bottoms and found 1,831 examples of those patterns. The following table lists how often the anomalies occur in the samples.

When I add throwbacks and pullbacks without partial rises and declines, I get the following.

The percentages drop, just as you would expect since the test excludes patterns with partial rises and declines.

Finally, I add partial rises and declines into the picture to get the following.

The table says that there are substantially fewer partial rises and declines that lead to throwbacks and pullbacks. So that's the answer. It's less likely that a throwback or pullback will occur after a partial rise or decline.

-- Thomas Bulkowski

Monday 01/25/2010. Market Monday: The Week Ahead

A Brief Look Back

The following are economic reports that moved the markets last week. The numbers refer to the close-to-close move in the Dow industrials.

For the week...

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast. The "Dow Moved" column is the close-to-close price change of the Dow industrials on the release day from the prior trading day, the last time the report came out.

Options Expiration

No options expire this week.

CPI: Chart Pattern Indicator

As of 01/22/2010, the CPI had:

The chart pattern indicator is bearish with 2 of 3 full triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal than half triangles.

Other

Earnings season is either underway or should be starting soon. The sessions could be more volatile.

I found 1 pipe bottoms last week, which is neutral. Large numbers of pipe bottoms often signal the start of a short to intermediate-term move up before price curls back down, forming an unconfirmed double bottom. I think of it as the signal for the first bottom of a potential double bottom.

The following industries, of 52 that I follow, were the best (1) and worst (52) performing.

My Prediction

The last three trading days certainly took me by surprise, but this week is a new beginning. I expect a recovery from the 4% decline, as the red lines show.

I see support below where price is now, denoted on the chart of the S&P 500 index by the blue line. The chart is on the daily log scale, by the way.

The Federal Reserve will tell us late Wednesday that the sky still is not falling, but it was a close thing. If politics come into play they may say something about grabbing money from banks. I don't think that will happen. President Obama has jumped upon that train and derailed the markets as a result. I don't expect the Fed to raise interest rates, but if they do, then look for the Dow industrials to drop maybe another 200 points. I expect the day to be quiet until they announce and then the market should rise.

If I am wrong and sellers overwhelm the markets, look for the S&P to drop to the green line on the chart, stopping at about 1050 where it intersects the trendline and should find support. That would return it to near the launch price (A), at 1030.

-- Thomas Bulkowski

Thursday 1/21/10. Mechanical RSI Trading System

Each day, I update the test portfolios that appear on the upper right of each page on this website. One of the portfolios, the RSI has a good reputation of knowing when to buy, but not when to sell and the draw down can be huge.

Active Trader magazine, in their February 2010 issue, discuss an article titled, "RSI scale-out system," by Volker Knapp It's similar to my test portfolio but it scales out of trades. Here are the rules.

1. Long side only.
2. Buy at tomorrow's open when the 14 period RSI goes below 30.
3. Exit 25% of the position at tomorrow's open each time the 14 period RSI increases by 15 points, namely 45, 60, 75, and 90.
4. Set a stop loss for the entire position if price falls below the entry price by 5 times the 20-day average true range (ATR).
5. Sell the entire position if it is held 300 days without any sell activity.

For their tests, they used these guidelines on a portfolio of 17 stocks from Nov 1999 to Oct 2009:

• Begin with a $100,000 portfolio
• Allocate 20% per position
• Commissions are $0.01 per share and 0.05% slippage per trade.

They had 444 trades that made a net profit of $75,904 or 75.9% with a max draw down of 21%. The win/loss ratio was 70% with a 9.2% average profit. The average winning trade made 19.5% and the average losing trade lost 14.9%.

They mention that no trade hit the 90 RSI reading and say that most exits are time based. My test portfolio rarely hits 80 (4 times in 2 years in over 100 trades). A top end of 75 might work better as the last exit instead of 90. My feeling is that entering when the RSI is climbing above 30 from below would be a better method than when it's declining below 30. The RSI can remain below the 30 threshold for months and the stock keeps declining. On the last exit, at 75 or 90 or whatever value you choose, having the RSI dropping down from above tends to help avoid exiting too soon as price climbs.

-- Thomas Bulkowski

Tuesday 01/19/2010. Market Monday on Tuesday: The Week Ahead

A Brief Look Back

The following are economic news or events that moved the markets last week. The numbers refer to the close-to-close move in the Dow industrials.

For the week...

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast. The "Dow Moved" column is the close-to-close price change of the Dow industrials on the release day from the prior trading day, the last time the report came out.

Options Expiration

VIX and RVX expire on Wednesday.

CPI: Chart Pattern Indicator

As of 01/15/2010, the CPI had:

The chart pattern indicator is bearish with 2 of 3 half triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal than half triangles.

Other

Earnings season is either underway or should be starting soon. The sessions could be more volatile.

I found 1 pipe bottoms last week, which is neutral. Large numbers of pipe bottoms often signal the start of a short to intermediate-term move up before price curls back down, forming an unconfirmed double bottom. I think of it as the signal for the first bottom of a potential double bottom.

The following industries, of 52 that I follow, were the best (1) and worst (52) performing.

My Prediction

The Dow industrials, pictured on the right, seems to be following a rising channel, which I show as two parallel blue lines.

The day after the Martin Luther King jr. holiday, price shows a slight tendency to close higher only 46% of the time. With Friday seeing the Dow drop 100 points, I expect price to rebound on Tuesday, but not to any great extent.

The remainder of the week should be uneventful, based on the economic reports. However, earnings season is starting up, so maybe a few companies can create some enthusiasm and make it a fun ride.

-- Thomas Bulkowski

Thursday 1/14/10. Are You Losing Money? Stop Trading!

In 2007, I came to the conclusion that the type of trading I was doing wasn't working as well as other techniques, so I decided to change. That was strange since I made over 22% in 2006, handily beating the closest average, the Dow industrials which had a gain of 16.3%. I sold the stock (Michaels Stores was taken private) that had powered my results in prior years, so I started looking for replacements.

The trade in Pioneer Drilling (PDC) shows the type of behavior I was seeing in some of my trades.

I bought the stock as it broke out upward from the congestion zone, but price collapsed. Soon, it was clear that it had reversed and broken out downward instead, so I sold the stock, taking a loss.

I should have recognized the potential for price to move lower because it often takes the shape of a measured move down chart pattern. I show that pattern beginning at A, dropping to B, correcting to C, and finishing at D. That's hindsight, of course, and hindsight is always 20-20.

As it happens from time to time, I sold just days before price resumed its upward move. If I held on, I could have doubled my money, as the chart shows. In other words, this trade tells me that a longer hold time would have been rewarding.

As part of your year-end review, look at your entry and exit timing. If you find you are entering early or late, then make changes. If you are exiting early (most likely) or late, then make changes.

For me, the answer was to focus on fundamentals, a return to the way I started my investing career. By stopping trading and focusing on timing the exit, coupled with a market that has rewarded holding, my results improved. I expect to double or triple my money within 2 to 3 years, mostly by holding what I own now. I will trade from time to time, especially when opportunities present themselves (like an inverted dead-cat bounce), but I can make more money by ignoring the weekly ups and downs and not get shaken out of trades like PDC illustrated here.

With your trades, ask yourself if you held longer, would you have made more money? The answer is probably yes. One solution is to use a higher time scale to exit. If you're a day trader on the 1-minute scale, exit using the 5-minute scale. If you're a position trader using the daily charts, then switch to the weekly scale on the exit.

-- Thomas Bulkowski

Tuesday 1/12/10. Tutorial Tuesday: Using Mirrors for Price Prediction

Imagine you own shares of Boeing, pictured on the weekly scale, to the left of the vertical yellow line. How can you predict where the stock will turn in the future?

The answer is to use price mirrors. This is just a fancy and shorter way of saying support and resistance.

Price peaks at A, drops down and then rises to form a second top at A, on the right side of the yellow line. Peak A is mirrored across the yellow line not in time but in price. In other words, the price at the left peak A is similar to that on the right peak. Of course, many of you will recognize the twin A peaks as a double top. It becomes an actual, valid double top when price closes below the low between the two peaks.

Look at the twin peaks B. Both are at a similar price level, with the B on the right a bit below that of the left peak. The pattern now becomes a complex head-and-shoulders top, one with two heads and two shoulders.

The two C peaks do not have a reflection across the yellow line but they form their own mirrored pair.

Peaks E and D have their mirrors across the yellow line as well.

Now let's look at the valleys. They form the same mirror pairs, don't they? Valleys Z and Z mirror each other in price. The Y on the right of the yellow line is lower than the one on the left. Two Ws appear, forming a small mirror, and the pair reflect across the yellow line by another pair of Ws on the right. Finally, the two Vs also reflect across the yellow line.

If you were to cover up the chart at the yellow line and just flop the left side onto the right, it would appear similar in shape. It would not be exact but similar. Sometimes, even the time between peaks and valleys is similar across some imaginary vertical yellow line.

These types of price mirrors can be a useful tool to help predict where price is going to pause when it begins retracing. Obviously, if the stock continued to climb to the right of the yellow line, we would not be having this discussion.

That also brings up a caution, too. While mirrors can prove not only useful but accurate as well, they have their limitations. For example, look at the left peaks D and C. The Z valley could mark the imaginary yellow line between these two. I show it as a thin, vertical green line. Peak e is mirrored by E. Valley y mirrors at Y. But price continues to rise after the first peak C. Again, mirrors only work when price is ready to reverse. In the second C peak, the stock still had more up-move left.

Mirrors work on all time scales. Just keep in mind that sometimes a peak on the left won't be mirrored by one on the right. In the absence of anything else, mirrors can help you guess how price will move in the future.

-- Thomas Bulkowski

Monday 01/11/2010. Market Monday: The Week Ahead

A Brief Look Back

The following are economic news or events that moved the markets last week. The numbers refer to the close-to-close move in the Dow industrials.

For the week...

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast. The "Dow Moved" column is the close-to-close price change of the Dow industrials on the release day from the prior trading day, the last time the report came out.

Options Expiration

The following is courtesy of yahoo!finance and they stole it from The Options Industry Council.

Many options expire this week, so traders will be looking to close out their positions ahead of that, and that suggests increased volatility (large daily price swings).

CPI: Chart Pattern Indicator

As of 01/08/2010, the CPI had:

The chart pattern indicator is bullish with 3 of 3 full triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal than half triangles.

Other

Earnings season should be starting soon.

I found 1 pipe bottoms last week, which is neutral. Large numbers of pipe bottoms often signal the start of a short to intermediate-term move up before price curls back down, forming an unconfirmed double bottom. I think of it as the signal for the first bottom of a potential double bottom.

The following industries, of 52 that I follow, were the best (1) and worst (52) performing.

My Prediction

I show the S & P 500 index on the daily scale in the associate chart.

Based on the economic reports that are due out this week, I don't expect fireworks. The FEDs beige book comes out on economic conditions but it's probably a lot like the weather. Just look outside your window and you'll know how bad things are.

On Thursday, retail sales come out and that might generate some excitement. I expect good reports from retailers and that's why you see the fourth red line moving up.

The rest of the week I expect the S&P 500 to move horizontally. The recent run from the late December low has been an almost straight-line one. Those can last longer than anyone expects but sooner or later price has to pause. I see that happening, perhaps this week, starting with a small retrace at the start of the week to compensate for the Dow's 190 point gain last week. Then a recovery on retail sales as I mentioned.

-- Thomas Bulkowski

Thursday 1/7/10. Searching for 10-Baggers

The bee picture is from my garden when it was warmer. It's serves as a reminder that beauty lies beneath those snow drifts and cold temperatures.

In case you haven't heard of a 10-bagger, it's a stock that rises by 10 times or more from its original price, and it does this within 5 years. The time limit is one I impose, so it is arbitrary.

I am finishing a chapter on 10-baggers, and below I share some of my finding with you. Here are the important elements I uncovered in stocks that rise by 10 times. In all cases, the criterion is based on the stock before it begins its move up, not sometime during the rise.

• Almost half (41%) of 10-baggers take a full 5 years to complete.
• 55% of the samples had a starting price below $5, but only 2% were below $1.
• The first year is when 10-baggers rise most.
• 77% were small caps. Market cap is shares outstanding times the current stock price.
• Half the samples had a price to book value below 1.5.
• Capital spending decreased 59% of the time from the year before the 10-bagger began.
• 35% of the time, the stocks had price to cash flow below 1.0.
• 91% of the stocks did not pay dividends.
• 77% had long term debt.
• Net profit, P/E ratio, and ROE are almost meaningless when searching for 10-baggers.
• 53% of the stocks had price to sales ratios below 1.5
• 51% had return on equity below 12%.
• In 84% of the samples, the company issued more shares than were outstanding in the prior year.
• Which industries had the most 10 baggers? Semiconductors (first), home builders (second), internet, and semiconductor capital equipment.

The above analysis used data from 1992 to 2007 on over 1,000 stocks, but few actually contained 10-baggers. The best time to go shopping for 10-baggers is just before the bull market bubble (as in 1998 when 81 ten-baggers appeared), and just as a bear market ends (like now!), such as in 2002 when 72 ten-baggers occurred in the stocks I looked at.

Happy hunting!

-- Thomas Bulkowski

Tuesday 1/5/09. Tutorial Tuesday: The 38% Exit

The home-built program I use to track my stocks allows me to view the allocation of each stock and each industry with the push of a button. When I felt as if Pinnacle West Capital (PNW) was overbought and it was time to sell, I looked at my allocation. I had 19% of my money in the stock. The next closest allocation was 6% in another utility stock. Even after selling a portion of it, I still have 13% wrapped up in the stock. If I need to sell or if the stock hits my next price target (39-40), I know where to go to find the cash.

Anyway, I bought the stock several times and this sale matches a buy I made on August 1, 2008. I entered the stock on an ascending triangle breakout, and received a fill at 33.26. At the time, the stock paid a 6% dividend.

Zoom ahead to December 15, the day before I sold. My reason for selling the stock was for diversification. I wanted the money to buy other stocks I liked and to cut the allocation, as I already discussed. The Wilder RSI (relative strength index) said the stock was in the overbought range, but it can stay that way for months. The commodity channel index (CCI) said sell.

What I really wanted to explain about this trade is the 38% Fibonacci extension. I have written many times about using Fibonacci retraces, 38%, 50%, and 62% of the prior move. In this case, I used an extension of the AB move. Here's how it's done. In this trade, I used the widest points in the broadening top chart pattern. Point A is at a high of 35.48 and the low is at 31.08 for a height of 4.40. Multiply this by 38% and you get 1.67. Add that to A to get the target I show as a green line, at 37.15. Notice how the stock began to turn near the extension level.

Since the stock had moved up in a straight-line run for 1.5 months, I felt that it just might retrace and wanted to capture as much profit as I could. My notes also say a evening star candle appeared (shown in the figure to the right), and price had closed lower two days in a row. Although I suspected then, and still do, that the stock will continue up, I sold a portion of my holdings at 37.59.

I made 13% on the stock but it qualifies as a long term gain. The kicker is, I also collected dividends which pushed up my total return to 21%. How do you spell green? M-O-N-E-Y!

-- Thomas Bulkowski

Monday 01/04/2010. Market Monday: The Week Ahead

A Brief Look Back

The following are economic news or events that moved the markets last week. The numbers refer to the close-to-close move in the Dow industrials.

For the week...

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast. The "Dow Moved" column is the close-to-close price change of the Dow industrials on the release day from the prior trading day, the last time the report came out.

Options Expiration

No options expire this week.

CPI: Chart Pattern Indicator

As of 01/01/2010, the CPI had:

The chart pattern indicator is bearish with 2 of 3 half triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal than half triangles.

Other

I found 1 pipe bottoms last week, which is neutral. Large numbers of pipe bottoms often signal the start of a short to intermediate-term move up before price curls back down, forming an unconfirmed double bottom. I think of it as the signal for the first bottom of a potential double bottom.

The following industries, of 52 that I follow, were the best (1) and worst (52) performing.

My Prediction

After Thursday's big drop, one can assume some type of rebound will occur in the Dow industrials, and I show that in the chart.

This week, I expect a partial decline to form. That happens when price drops but does not come close to the bottom trendline before moving back up and staging an immediate upward breakout. Rectangle tops and bottoms, and the various types of broadening patterns show partial declines and partial rises.

Friday will be the big day because that's when the unemployment report comes out. With holiday hiring, I expect the unemployment rate to continue to decline, but that's just a guess. I think that the market will like the news and send price higher, perhaps rising about the top of a rectangle top chart pattern. I show that as the two horizontal red lines that has mostly contained the Dow for about a month. In other words, the Dow has been range bound.

-- Thomas Bulkowski