As of 11/20/2024
Indus: 43,408 +139.53 +0.3%
Trans: 17,002 -26.31 -0.2%
Utils: 1,055 +1.25 +0.1%
Nasdaq: 18,966 -21.33 -0.1%
S&P 500: 5,917 +0.13 +0.0%
|
YTD
+15.2%
+6.9%
+19.7%
+26.3%
+24.1%
|
 46,000 or 43,000 by 12/01/202418,000 or 16,600 by 12/01/20241,075 or 1,000 by 12/01/202420,000 or 18,400 by 12/01/20246,100 or 5,800 by 12/01/2024 |
As of 11/20/2024
Indus: 43,408 +139.53 +0.3%
Trans: 17,002 -26.31 -0.2%
Utils: 1,055 +1.25 +0.1%
Nasdaq: 18,966 -21.33 -0.1%
S&P 500: 5,917 +0.13 +0.0%
|
YTD
+15.2%
+6.9%
+19.7%
+26.3%
+24.1%
| |
|
46,000 or 43,000 by 12/01/202418,000 or 16,600 by 12/01/20241,075 or 1,000 by 12/01/202420,000 or 18,400 by 12/01/20246,100 or 5,800 by 12/01/2024 | ||
I wrote this article for Active Trader magazine in March 2006. They accepted it for publication, but never printed it nor paid for the work to write it (no kill fee). The figures will look compressed because I resized them to better fit this page.
Michaels Stores was taken private, so it no longer trades. Here's the article.
Technical methods are used to determine buy and sell points for a 60 percent gain. Learn about the 1-2-3 trend change method for trading.
I like Michaels Stores because I have made a lot of money trading the stock. I have also lost a lot on paper when the stock dropped by double-digit percentages in a single day, on more than one occasion. The trade that follows is an unusual one because the buy signal comes not from the chart patterns I normally use. Learn from my success and my mistakes.
The first figure shows the stock as I viewed it on my chart. Starting on the left is a head-and-shoulders top that warns of a coming price decline. The green neckline is the sell signal but since it slopes downward, the right shoulder (RS) armpit (point A) is a more timely sell location. When price drops below the price at A, sell.
Starting at the head, price declined in a diverging manner meaning the swings widened, forming a descending broadening wedge. Fifty-eight percent of the time, the breakout from wedges is upward, and that's what happened at B, the first close above the breakout price shown as the horizontal red line. Price moved horizontally for about two weeks as if gathering strength for the next move.
When the move came, the result was severe. The market did not like the announcement that earnings were on the low end of expectations, and the company cut full year earnings estimates because of weak October sales. The stock plummeted faster than a skydiver without a parachute, dropping 24 percent. Price recovered as it does in most well-behaved dead-cat bounces (DCBs) before easing lower. Three months later, price gapped lower again, this time dropping by 22 percent. The cause for the second drop is unknown.
In a study of DCBs, 26 percent of stocks showing a DCB decline at least 15 percent (in one day) within three months and 38 percent decline at least 15 percent (in one day) within six months. In other words, one DCB follows another. This behavior is often earnings related. A company cannot change direction quickly, so additional earnings shortfalls occur.
My interest in the stock piqued on the last bar shown. Why? Because that day marked a trend change. The above figure shows the procedure for determining when the trend changes. Credit for the method belongs to Victor Sperandeo from his book, Trader Vic - Methods of a Wall Street Master (Wiley, 1991).
Step 1 is to draw a down-sloping trendline from the highest high to the lowest low on the chart such that the line does not cross price until after the low. Instead of drawing a line connecting points A and B, which would have meant an additional delay for price to rise, I drew the line as shown in blue, connecting the high at B to the low at C, without crossing any prices until after C. The point where price closes above the trendline is the first indication of a trend change.
Step 2 says that price must stop making lower lows and should retest the low. I show that as point 2 on the chart. This is a higher low and an attempt to return to the low at C. The last step of the three-step method is for price to climb above the prior minor high. I define the minor high as the highest high between the low at C and the retest at 2. The green line represents the buy signal. When price passes all three steps, the trend has changed from down to up.
Before I discuss the buy, let's discuss finding a trend change when price tops out. I show that scenario in the next figure (above). The same three conditions apply. First, draw a trendline from the lowest low on the chart (A) to the highest high (B) such that the trendline does not cross price until after the highest high. I show the trendline as the blue line. Second, the retest of the high occurs at 2. Price may poke above the high at B or fall below it, as in this case, but it's clear that price has made a lower high or stopped moving higher. Third, look for price to decline below the low posted between the high at B and the retest at 2. The horizontal green line marks the completion of the 1-2-3 trend change from up to down. When price meets all three conditions, a sell signal occurs.
How often does the 1-2-3 trend change method correctly signal a trend change? In a study of 101 down-sloping trendlines drawn in 100 stocks from July 1991 to July 1996 that met the three conditions of a trend change, 73 percent showed price rising more than 20 percent. The 20 percent figure is often used to determine a change from a bear to bull market, so that's the benchmark I used.
For up-sloping trendlines, I used 50 of the same stocks covering the same period and found that 43 percent of the time in 67 samples, price declined at least 20 percent below the trendline break. Thus, the 1-2-3 trend change method works best for down-sloping trendlines, not up-sloping ones.
Returning to the trade, in my notebook that accompanies each trade, I wrote, "This is near the yearly low, so the risk is reduced. The company has raised earnings estimates recently, so that's good, but retail sales from major retailers (for example, Wal-Mart) were soft in March. MMU target is 16, Symmetrical triangle SAR apex at 16.50. Downside is old low at ten, far from the 14.23 purchase price. You might think of this as a 1-2-3 trend change trade, suggesting an upward price trend now. With war with Iraq winding down, the economy might rebound. There are many bottoms at 14.50, so that might be a repel point too. If price drops, I plan to buy more because I think it's still a good stock with upside potential and the nearby store seems to have the parking lot full."
MMU stands for a measured move up, a stair step chart pattern. The MMU theory says that the rise from A to B, called the first leg, should approximate the move from C upward. Often, the rise after C approximates the slope of the AB move (but offset and not as steep) and it matches the duration, too.
In tests of 577 MMUs found in 473 stocks from July 1991 to September 2003 (excluding the bear market from March 2000 to October 2002), the average rise was 46 percent in 87 days for the first leg and 32 percent rise in 60 days in the second leg. The corrective phase retrace, the move BC compared to AB in the above figure, most often ranged from 40 percent to 60 percent. Based on these tests, expect the second leg to be shorter and top out more quickly than the first leg.
I show the symmetrical triangle apex where I expected price to stall (about 16.50). The low at A represented a possible stop loss location but at 30 percent below the buy price, it was much too far away. A better location would be the low at C, 15 percent away. That's still above the ten percent or less I like to see for stops. That should have served as a red flag, a warning not to take the trade. However, with a longer-term holding, I often brush aside such concerns because I am looking for an outsized reward.
The next figure shows how the trade progressed. The CD move did not approximate the AB slope because AB was too steep to be sustained. CD also turned into a much longer rise than the AB move. Predicted overhead resistance at 16.50, the triangle apex shown by the green line, did not have much influence although price did revolve around the line near D.
On the last bar shown, I was getting nervous about the stock. Here's my notebook entry for the trade. "1/10/04. I intend to sell half my holdings at Monday's opening (it's Saturday). Three falling peaks suggests further downward spin. The stock busted below support in December 2003 (a small diamond bottom). November head-and-shoulders top is sending prices lower. This should find support at 18.50-20 from the horizontal consolidation region in June-July 2003. Since price has closed at the daily low, that suggests a lower low Monday but, perhaps, a higher close. It could continue spinning down. It's broken below trendline support, the line starting in May 2003 and connecting the August and December lows. The head-and-shoulders measure rule says to expect a decline to 19.66 from the 22.50 neckline breakout."
The figure shows the elements mentioned in the notebook passage. The three falling peaks chart pattern forms using the head, right shoulder (RS), and peak E to mark three consecutively lower peaks. A close below the lowest valley between the three peaks is the sell signal.
The diamond bottom marks the December support I mentioned. I show a horizontal red line to mark the bottom of the area. The head-and-shoulders top is a reversal that forms at the top of the chart. A close below the neckline is another sell signal.
The horizontal consolidation region in June through July supports the formation of the diamond bottom in December. Finally, price piercing the up-sloping trendline also signals a move lower. The shares I sold are not those bought on April 11, but those dating back to two purchases in the summer and fall of 2002.
The next figure shows how the trade progressed. The sale on January 12, 2004 was untimely, despite the preponderance of bearish evidence suggesting a continued decline. Price bottomed the day I sold and then climbed. Fortunately, I only sold half my position.
On May 17, 2004, it was time to sell my April shares. My notebook entry says, "This is going to MMD down to 21, maybe more, so it's time to sell, especially with weak same-store sales and insider selling."
MMD is a measured move down and it works similar to a MMU. The first leg decline measures from the high at A to the low at B, the lowest low before I sold, projected downward from the high at C. This suggested a decline to below 21. As you can see in the figure, price didn't even come close. Unreliability is one reason why MMDs and MMUs are difficult to trade.
I sold at a split-adjusted price of 22.78, making 61 percent (including dividends) on the April 2003 to May 2004 trade. Since the hold time was over a year, it also qualified for long-term capital gains tax treatment. The good news is I still had shares bought in 1990 at a split-adjusted price of 88 cents in my portfolio. The March low (point C in the second figure) was a major turning point for the stock. It climbed to a high of nearly 44 in early June 2005. And that's when I should have sold.
Strategy: 1-2-3 trend change method for buying a long-term holding in a dividend paying stock.
Setup/conditions:
Entry: Buy when price meets the three conditions.
Stop:
Exit: Sell when conditions turn bearish.
-- Thomas Bulkowski
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