Bulkowski's Insteel Industries Trading Quiz

Price has broken out of the channel upward, on high volume.

Answer 1 (Buy?): Buy. Why? Because I know what's coming. Since you don't know what's coming, do as I did and do nothing. Answers 2 and 3 apply only if you decided to buy.

Answer 2 (target?): You can measure the channel height and project it upward from the top of the channel. The height, measured vertically, is $1.71. Added to the breakout price of 17.60 gives a target of 19.31. The price closed at 19.75, so that's no real help.

Answer 3 (stop?): Place a stop below the channel low, at A, 16.15. The close is at 19.75, a cool 18% drop. That's much too far. 2x volatility is $1.20, so a volatility stop at 16.80 is closer but still 15% away. The 3 red lines show a Fibonacci retrace of the move from A to the recent high. Placing a stop below the lowest of the 3 red lines (a 62% retrace), means a stop at 17.60. That still 11% but it's close enough with volatility being what it is.

I became interested in the stock a few bars before the last one shown on the above chart. Why?

A chart pattern developed, called a high and tight flag [HTF]. That's when price doubles (at least 90%) in 2 months or less. The launch point is at the base of the flagpole, at 16.15, and price peaked at 31.90, the day before the last bar. That's a climb of 98% in just over a month. I show the chart (and all charts) on the logarithmic scale. Notice how the price climb tends to flatten the channel and the price rise since August. What was a hilly, rounded landscape in the first chart is now a more sedate rise.

Here's my notebook entry for the trade when I bought on the last bar shown. "Date Bought: 2/14/06 at 31.03. Stop, % loss: 27.81 or 10% down. Volatility, stop: 27.10, 13.1%. Upside target: 30.21 high on 2/10 - 16.15 trend low on 12/28/05 = 14.06 height x 50% = 7.03. 30.21+7.03 = 37.24. Future market direction: Down? Score and price target: +2, 39.18 using generic score. SAR [support and resistance]: None above except round number at 35. Congestion from 30 to 28. Buy reason: HTF with upward breakout.

Indicators: RSI [relative strength index]: overbought. This chart is the RSI which says the stock is overbought and ripe to fall.

CCI [Commodity channel index] is the top chart. It shows a buy signal followed by a sell signal on the last 2 bars of the price chart (I only saw the buy on 2/13), from the CCI and DCCI lines crossing.

Middle chart is MACD [moving average convergence/divergence] which is bullish, high momentum on the histogram chart.

Bottom chart, Bollinger bands, show price riding up in the middle of the top two bands. Notice how the bands changed from a narrow width to a much wider one as price took off.

Dissecting my notebook entry, I placed a stop at 27.81, 10.3% below the buy price of 31.03. The volatility stop was too far away at 13.1% from the current close. I used the measure rule for HTFs, half the height of the flagpole to project a price target. That was 37.24. I scored the chart pattern using my scoring system for chart patterns (see my book Trading Classic Chart Patterns for the logic, but you won't find this pattern in the book). I used a generic score - the same scoring method as for classic patterns but I used average numbers to extrapolate the result for patterns I haven't applied the scoring method to. Clear as mud, right? It's not important. Scores above 0 have a better probability of hitting their price targets than those with scores below 0.

The industry, building materials, ranked 18 out of 46 for performance over the last 6 months (where 1 is best). Inside the industry, this stock ranks first out of 10 stocks for performance over the same 6 months. All that means is I like to see a strong industry movement and strong stock performance. Will the results prevent me from taking a trade? No.

As each day ticked higher, I looked at the stock and ran a volatility check. When the volatility stop moving up, I raised my stop. At one point, 2x volatility was over $3. That placed the stop much too far away, so I chose to narrow the spread. Why use a volatility stop? Because it offered the only way to set a stop except for guessing. Usually, I like to hide beneath a minor low but with a straight line run, there's no minor low! Nevertheless, the stop was often 10% or more below the current close. That's a huge give back but one that's necessary in order to stay in a volatile trade.

3/7/06. The stock closed lower and I figure everyone else will sell at tomorrow's open. In the past, the stock has tumbled on the open then recovered throughout the day. Except for today. It closed lower. With CCI signaling a sell 3 days ago, I think it's time to cut the giveback to 0 and exit.

Date sold: 3/8/06 at 39.89. Sell reason: I think this is finally topped out and everyone is going to head for the exits and quickly!

They did exit at once. The open at 39.89 was well below the prior close of 41.12. Price on the day I sold dropped to a low of 38.53, so I think I did well. The target was 37.24 but the scoring system had a target of 39.18 (based on the median rise of HTFs). I beat both targets. Since the trade ended, the stock has hit overhead resistance except for today. When I checked last, price was moving up again.