Chi-Osc


Conflicting Market Signals

February 25, 2013 (6:45 pm)

We explained in our post last Wednesday that the market would likely continue down on Thursday before re-testing the high’s early this week. As we expected, the market fell to an intra-day low on Thursday (down to $150) before rallying up to $152.85 this morning, just shy of its 52-week high formed last week. After that re-test, the markets completely rolled over and dropped nearly $4.00 into the close. That’s a 2.5% single day drop, from high to low. We’ve seen reversal after reversal over the past few days. That’s a sign of a transitory market. Since we’re sitting near a 5-year high, a transition from here can only be bearish. However, there are some conflicting signals that indicate a near-term rebound may already be due. There are a lot of charts here, so we’ll go through them relatively quickly.

SPY Failed Re-Test. After seeing a quick and significant sell-off last Wednesday and Thursday, the SPY rallied back to re-test its previous highs this morning. It got to within $0.50 of its previous highs before rolling over even more quickly than it had rallied. A failed re-test is an important piece of the topping process. After failing once, investors like to try a certain direction at least one more time before moving the opposite direction. They want to be confident that the shares are rejected at a certain price level and that demand has truly dried up. This is as true for the bulls as it is bears. With this failed re-test, the bears are now free to take over. However, that doesn’t necessarily mean that they will.

SPY Failed ReTest

SPY Trend Lines. Here’s another view of the sell-off. The bottom trend line (that the shares are now approaching) was formed by the November 16th bottom and the fiscal cliff bottom. On one hand, we now have a failed re-test that gives the bears the necessary runway to drive a correction. On the other hand, the SPY is reaching a significant trend line that may mark strong support and an inflection point. The shares, if they reach the bottom trend line, will also be oversold. We have an interesting near-term situation in the works.

SPY Channel

SPY Support Levels. Here’s yet another view of where the SPY sits. This morning, the shares rallied and tested the bottom trend line of the well-defined rising channel. They were clearly rejected at that trend line and dropped nearly $4.00 immediately. Oversold conditions will likely slow the selling in the near future. We doubt that investors will witness another day like today in the near-term, since the RSI is already so low. We will likely see consolidation around the current levels before dropping to $146, which is the first level of significant support. Below that is the gap that was formed after the fiscal cliff resolution.

SPY Support

SPY Rising Wedge. We’ve shown this chart multiple times over the past few weeks. The SPY shares were rejected at the upper trend line of this very long-term and significant rising wedge. We’ve seen negative divergence form over the past two and a half years, as well as decreasing volume. Both of these help to confirm that this pattern is to be taken seriously. Just for your knowledge, the implied price move is roughly $45, meaning the target of a breakdown is roughly $100 on the SPY (or about 1,000 on the S&P500). Interestingly, the bottom trend line currently sits at the $146 level, which we explained earlier as significant near-term support. We’ll likely see a bounce off this trend line before a more significant and sustained correction can begin.

SPY Rising Wedge

SPY Intermediate-Term Correction Targets. This next chart is not to be viewed as a near-term target, but instead on the intermediate-term. We expect to see the $140 level in the early May time frame. Our targets were derived by two independent methodologies that both happen to suggest the same price level. The first is a 100% measured move of the previous correction (Sept-Nov 2012). The second is a 61.8% Fibonacci retracement of the current rally. Both suggest the $140-$141 price level (again, likely around the early May time frame, not imminently).

SPY Targets

QQQ Failed Re-Test. Now let’s take a look at the NASDAQ. Just like the SPY, the QQQ’s saw a failed re-test of the highs and subsequent breakdown today. However, the QQQ’s are already within the oversold zone on the RSI. Since the first down leg was so strong, we’ll likely see a second leg down after a brief rebound or consolidation period.

QQQ Failed ReTest

QQQ Consolidation Zones. As we’ve recently discussed, the QQQ’s have formed a series of consolidation zones throughout the past four months. Each is has a tighter price range and shorter duration than the last. After last week’s sell-off, the shares today re-tested the highest consolidation zone and was firmly rejected. It’s now sitting at the bottom of the zone created after the successful resolution of the fiscal cliff. A 61.8% Fibonacci retracement of the recent rally gets us to fill the gap (almost exactly) that was created after the cliff resolution.

QQQ Consolidation

QQQ Long-Term Resistance Level. The chart below is self-explanatory. The $67.75 level represents significant, long-term resistance for the QQQ’s. Only a successful and decisive breakout would confirm a true bullish environment. Below it, the bears are in control.

QQQ Resistance

QQQ Head & Shoulders. This pattern is still squarely in play after the firm rejection of the long-term resistance level at $67.75. You can see the gap from the fiscal cliff sits directly below the current levels. If the shares continue to decline tomorrow, that gap represents a vacuum – meaning the shares will likely retrace the entire gap area. There’s no real support anywhere within the gap.

QQQ H&S

Volatility. This next chart is extremely important. It’s a bit complex, so we’ll decipher it one step at a time. The VIX measures the amount of volatility in the market. Low volatility implies a melt-up market, where complacency reigns and investors are confident that the market will continue to slowly rise. High volatility implies a turbulent market, marked by either (a) wild swings or (b) sharply falling prices.

VIX

On the chart above, we have two sets of horizontal lines. The first set are thick purples lines (of which there are 5), which mark each time the VIX hit a 70 RSI. At the bottom of the chart is the SPY index (which is representative of the broader market). You can see that each time the VIX hit a 70 RSI in the past year, there was a near-term rally in the markets. The second set are thin red lines. Typically, when the VIX runs above its upper Bollinger Band, the first close back within the bands marks a top in the VIX, and inversely, a bottom in the markets (the market tends to be inversely correlated with the VIX). We placed the thin red lines where the VIX drops back below its upper Bollinger Band. The green and red arrows indicate where this works (10 instances) and where it doesn’t (one instance). This may be confusing at first blush, but re-read it until you understand what we’re doing because it’s an important concept.

CONCLUSION. So you can see that there are a number of conflicting signals here. What we think it means is this. There will likely be downward pressure in the market because this first leg down after the failed re-test of the highs was so strong. However, since both the SPY and QQQ are nearing oversold levels and support levels in the near-term, we’ll likely see at least consolidation before a second leg down. This is also confirmed by the VIX indicator that signals a likely rebound from here. So the near-term crystal ball is obscured between the bulls and bears.

The intermediate-term course is a bit clearer. All signs point to re-testing the $146 level first, and eventually, the $140 level. Be cautious here, however, since we may not test it over the next few weeks. This is a two- to three-month process in our view.


Stocks to Watch (Part 5)

January 28, 2013 (11:30 am)

We’re updating these later than we hoped. We spent a lot of time over the past few days refining our site and were distracted from the underlying charts. Anyways… happy to be back to the fun stuff. Here are the charts we’re currently watching.

Apple. Whew. What a week for Apple. We drew out the chart below during the “parabolic” run in March of 2012, just as the shares were climbing up the (green) “bump” line. The chart illustrates a typical Bump and Run pattern. It was just something we were keeping an eye on, and it’s hard to believe that it came through to fruition. What happens is this. A stock is steadily climbing up the (blue) “run” line, before experiencing a dramatic rally (the bump). After spending some time climbing up the green bump line, they shares fall back to the blue run line. Subsequently, you’ll most often see shares retrace the entire rally and fall back to where they initially began the parabolic aspect of the rally. It can be argued that the bump began either before or after the post-earnings gap in late January – so either $425 or $440. The shares have since found support at that $440 level.

AAPL

Apple’s Falling Wedge. Continuing on with another Apple chart, we’re taking another look at the falling wedge that we outlined numerous times in the past. We hoped – and expected – that an earnings bump would break the shares to the upside. Clearly, that was wrong. We experienced a dramatic breakdown. From a strictly fundamental point of view, the shares are deeply undervalued here in our view. 10x LTM earnings is simply too low. Even if growth was completely done for Apple, we should see it trade more in line with Microsoft, which is trading at 14x LTM earnings. So with that, it wouldn’t be shocking to see the recent drama in the price action represent a false breakdown of the falling wedge. When we look back, the current $450 level may be akin to the $644 level in late March 2012 – simply a momentum trade without fundamental backing. With sentiment in the toilet and every voice on CNBC calling for the low $400’s, $300’s and some even expecting $200’s, now may be the right time to get back in (for those who aren’t already). Shares can become overextended to both the upside and the downside. We believe it has simply moved too far too fast to the downside. A relief rally should take hold, which may give fundamental buyers more comfort to get back in.

AAPL Falling Wedge

Amazon. We went short Amazon on Friday afternoon, as it hit the top trend line on overbought conditions. There should be a pull back and consolidation here.

AMZN

Broadcom. BRCM is sitting at the bottom trend line of a rising wedge, after we saw a false breakout to the upside. We expect to enter a bearish position on a breakdown.

BRCM

Berkshire Hathaway. We entered a bearish position in BRK.B a couple of weeks ago, and it has continued to rise. We’ve highlighted “overbought” Chi-Osc conditions over the past year. 7 of the last 10 times we saw these levels has led to a sell-off. Two of the remaining three instances saw at least consolidation, if not a slight pull back. The only time it continued higher was when we took a bearish position. The sell signal was triggered again late last week, so we feel comfortable holding our position. The shares gapped well above their upper Bollinger Band two weeks ago and hasn’t even consolidated since then. Further, over the last three days, we’ve seen an “evening star” form – a bearish topping pattern. It forms when a large white candlestick is followed by a black candle (that begins at a higher price, but closes below the top of the previous candle). It is followed by a red day, verifying the pattern.

BRKB

Gold ETF. GLD formed an enormous falling wedge over the past three months. We entered a bullish position when the shares broke out. A bull flag we had hopes would push the shares higher failed, and we’re again re-testing the upper trend line of the wedge. We’re still comfortable holding our position here and expect higher prices ahead.

GLD

Google. GOOG has formed a number of wedges over the past few days. First, there’s a three month rising wedge (blue). Second, the shares formed a bullish falling wedge as it broke out of the larger one. It gapped up back into the larger wedge and is now forming another bearish rising wedge. And it’s doing so with negative divergence. We entered a bearish position on Friday afternoon as it touched the top trend line.

GOOG

Netflix. Another doozy. We went short NFLX as it touched the top trend line of a multi-month rising wedge and entered overbought conditions. It has since surged higher. We took another bearish position on Friday afternoon. We believe it will fill at least some of the enormous gap that remains open, but are watching closely.

NFLX

Nike. We entered a NKE long position as it slowly broke out of an ascending triangle. On Friday, the shares hit our $55.50 price target, so we sold our position.

NKE

Research in Motion. Shares of RIMM leaped out of an ascending triangle over the past two weeks. As it surged past our expected price target of $14.50, we entered a bearish position with the expectation that it would retrace a portion of its rally. The shares, instead, continued climbing. RIMM shares trade primarily on momentum. We expect that this move will be done shortly and momentum traders will bring shares the other way. RIMM introduces its new operating system on Wednesday. We’ll wait to see what happens there. With the shares up 100% in the past three months, expectations are through the roof. We don’t expect these prices to hold.

RIMM


Is Apple Setting Up for a Blowout?

January 23, 2013 (12:00 pm)

Apple’s January earnings will finally be out in just four and a half short hours. Are the shares setting up for a blowout? Here’s what the charts are telling us.

The Falling Wedge: As we’ve mentioned on numerous occasions, Apple has formed an enormous falling wedge over the last four months. Each significant rally since the start of the correction has ended right at that top trend line. And each subsequent lower low has formed a well-defined lower trend line. The bottom trend line was temporarily breached, creating what’s known as a “false breakdown”. It’s happens quite often. The bears get one last shot at trying to break the pattern down, before the bulls get to make their move. We were hoping to be resting right at that top trend line as we head into earnings, but that’s probably too much to ask of the market. This afternoon, we’ll know whether this pattern will break out. It has a target move of roughly $200 (likely to take place over the next 3-4 months).

AAPL Falling Wedge

Significant Trend Lines and Resistance: We’ve laid out two important trend lines (orange and blue; the purple is not relevant at this time) Apple has faced throughout this correction. The orange trend line coincides with the top of the falling wedge. We’ve also included blue horizontal lines where we expect the shares to see moderate support/resistance going forward.

AAPL Trend Lines

Long-Term Divergences: It’s important to note that multi-week RSI and Chi-Osc divergence formed just before a significant change in trend. During the end of the March/April and the August/September rallies, we saw negative divergence. This happens when the shares make a higher high, but the technical indicators (in this case, RSI and Chi-Osc) fail to make higher highs. It’s a signal that momentum is dying down and tends to precede changes in trend.

As it happens, we’ve seen just the opposite take place over the past eight weeks. Both RSI and Chi-Osc have formed higher lows each time Apple’s shares have formed lower lows. This signals that the momentum of the bears has been deteriorating, and a change in trend to the bulls favor is increasingly likely.

AAPL Divergences

Long-Term Rising Channel: This was our favorite chart to watch up until it broke down in mid-December. We had high hopes in early December that the trend line would hold. It didn’t. We left much of the chart the same, so you could review our previous thoughts on the outcome.

The reason we included it here is this. We believe the breakdown over the past five weeks was simply a reaction (or, more appropriately, an overreaction) to the upside breakout we saw during the August/September rally. We expect the shares to trade back inside this channel in the coming weeks.

AAPL Long Term Rising Channel

Monthly Consolidation Trends: We created this chart late last night as we attempted to find new patterns we hadn’t seen before. This one caught our eye. It seems like every rally since the 2009 low has ended with a 5 month consolidation period. The recent 30% correction was much more extreme than the previous consolidation periods. But that doesn’t necessarily mean the trend has changed. Importantly, each of the consolidation periods took place with decreasing volume, making them look like bull flags. We are excited to review this chart in the coming weeks and months to see whether our hypothesis holds true.

AAPL Consolidation Periods

Island Reversals: If the shares continue to trade and end today’s session near the $510 area, we could see an island reversal (more on island reversals here). Assuming the company meets or beats estimates, and we see a gap up tomorrow, it would form a very clear island bottom. For this reason, it’s likely more helpful from a technical point of view for the shares to remain confined today.

AAPL Island Bottom

Head & Shoulders Set-Up: Since early 2010, the shares have formed three large head and shoulders formations that, in each instance, ended at the long-term rising trend line (dark grey). A rally has preceded each of these cases, and a dramatic rally has followed the last two. While we’ve broken down from the long-term rising trend line, it may prove to be just a small blip. If the shares can rally after earnings, we may see a dramatic rally follow.

AAPL H&S

The Doji Reversal: Lastly, we’d like to throw out another meaningful pattern. When you see a number of doji patterns back to back, it tends to precede a trend change. It’s a signal that the bulls and bears are have a fierce fight near the end of a trend. We’ve seen a number of back-to-back doji patterns over the past few days.

AAPL Doji

We’ll be updating our thoughts throughout the day. Please share your thoughts and comments below.


Stocks to Watch (Part 4)

January 21, 2013 (7:00 pm)

We’ll be watching a few charts as the week kicks off tomorrow. Generally, we remain bearish on the markets. The SPY and QQQ’s leaped above their upper Bollinger Bands and became overbought. Volatility has plummeted. We expect that the most likely outcome is a trend reversal coinciding with earnings. A majority of stocks that we’re watching have a bearish tilt, and have seen significant rallies into earnings. Expectations are high heading into earnings. That is not a bull’s friend.

American International Group: We just caught on to this one. Too late to participate in the first move, but this one likely has more room to run (on the downside). The shares formed a well-defined rising wedge over the last 11 weeks and recently broke down. The shares re-test the lower trend line and failed at that resistance. The target price is around $33. We’ll see if we can get a good bearish entry this week.

AIG

Broadcom: We participated in the move down in BRCM before it lept above the upper trend line of its rising wedge. It looks like we saw a false breakout on Friday, and the shares have since fallen back within the pattern. That’s a bearish signal. We’ll keep a close eye on this one.

BRCM

Berkshire Hathaway: We entered into a bearish put position in BRK.B in early January. It has slowly and steadily moved up on declining volume. The RSI has been overbought. The Chi-Osc is at levels that have tended to precede near-term sell-offs (red vertical lines), and it leaped above its upper Bollinger Band two weeks ago with no retracement. In the past, the shares have sustained these types of rallies for two or three weeks before retracing a significant portion of the move. We’re patiently waiting for a reversal. As always, if we see evidence to the contrary, we will not hesitate to close our position for a loss.

BRKB

General Electric: We started reviewing GE’s charts over the weekend. It has been forming a very substantial symmetrical triangle and the shares broke out on Thursday (with follow through on Friday). The implied price target of this move is $3, which could bring the shares up to $24.25. We’ll be watching for an entry this week.

GE

Gold ETF: As we tweeted on Saturday, GLD has been forming a picture perfect falling wedge and has since broken out. After re-testing the upper trend line, the shares rallied and have formed a bull flag. We expect it to continue up and are holding our positions.

GLD

Netflix: We entered bearish NFLX positions last week. Its rising wedge broke down and failed on a subsequent re-test of the lower trend line. We remain bearish and plan on holding our positions.

NFLX

Don’t hesitate to reach out with any questions or comments.


Stocks to Watch (Part 3)

January 14, 2013 (6:00 pm)

We made some trades in our Long/Short and Multi-Strategy Portfolio’s during today’s trading session. We’ll explain those trades here, along with some other charts we’re watching.

Boeing: We got back into a BA short position today at $76.62. We previously shorted the first break of the rising wedge, and were surprised by the quick reversal off the $73.50 level. We held the short position expecting it to be a re-test of the lower trend line. On a subsequent breakdown, we covered our short position at a small gain. The chart pattern became too messy for our initial thesis.

However, this morning it ran back up to that lower trend line where it again faced resistance. We entered a new bearish position here expecting the resistance to hold. We will cover the position if the shares again re-take the rising wedge and have a stop at $77.12 ($0.50 above our initial position).

BA

Bank of America: We took a bearish position in BAC as it broke through an 8-week rising channel. It may be forming a symmetrical triangle here as it consolidates at lower levels, which is a bearish indication. We will continue to hold this position unless it is able to retake its 50 DMA on volume.

BAC

Chipotle: We took a bearish position in Chipotle as it broke down from a multi-week rising wedge. It has since rebounded slightly and has re-tested the lower trend line twice. It failed both times. We expect lower prices from here.

CMG

Google: We covered our short and put positions in Google late this afternoon. We initially took these positions after it formed a clear negative divergence with RSI as it tested the upper trend line of a multi-week rising wedge. We took profits today in the put positions (26% gain) and short positions (3% gain) only three days after we got into the positions. The shares are becomming oversold just as they’re now reaching the lower trend line. They will likely find support there in the near-term.

GOOG

Netflix: We took a short position in Netflix this afternoon as it reached the upper trend line of a multi-week rising wedge. It did so as it approached overbought conditions. One potential outcome is a false breakout to the upside as it jumps into overbought territory before falling back into (and eventually below) the wedge. Another outcome is consolidation within the wedge until earnings. Of course, the last option is for the shares to lose the lower support line. We are fine holding our short positions through any of these three eventualities and expect lower prices in the intermediate-term.

NFLX

Nike: We entered a long position in NKE this afternoon. It has formed an ascending triangle and broke out this morning. One thing we’re watching for is confirmation of this breakout. We placed a stop at $52.72 ($0.50 below our opening price) in case this turns out to be a false breakout.

NKE

Research in Motion: RIMM has formed a fairly substantial ascending triangle and broke out on Friday. A 100% measured move would have brought the shares to $14.50, which would have been a huge move. It raced past that measured move, and we believe it is overextended here. We shorted the shares at $14.89 as it hit extreme overbought conditions. It should retrace at least 50% of its recent move.

RIMM

VIX (Market Volatility): A few important findings in the VIX chart. First, market volatility is approaching the lowest RSI levels seen over the past year (orange). It moved down so quickly that it almost jumped below its lower Bollinger Band. Second, it has formed a long-term trend line (blue). Each of the past two instances where it touched this trend line over the past year, the SPY saw a 2 point decline within the following week. Just something to keep an eye on.

VIX2

Conclusion: Our outlook remains bearish on the markets through the intermediate term. A majority of the charts we review have a bearish bias, either due to bearish chart patterns or overbought technical indicators. We will continue to keep in mind that the Fed is pumping liquidity into the system. However, a significant pullback is due within the next few weeks. We don’t expect a re-test of the November lows, but do expect to fill the gap created on the positive outcome of the financial crisis. Let us know your thoughts in the comments.