Oversold


Calling the End of the Correction

June 9, 2013 (2:00 pm)

On Thursday morning, we set Twitter ablaze with numerous charts showing strong buy indications and several other explanations of why a market bottom was imminent. For those who follow us on Twitter, we hope our analysis allowed you to make some profitable trades. For those who don’t, we apologize for not remarking on our site more quickly. You can follow us @three28capital.

Click on any chart below to make it full screen.

On Wednesday night, the SPY closed at $161.27, very near the 50 day moving average, and the NYMO (NYSE McClellan Oscillator) closed at an extreme level. That was our first indication that a bottom was near.

On Thursday in the early afternoon, the SPY was straddling the 50 DMA at the $160.50 level. We viewed this as a very strong buying opportunity and purchased several June monthly call spreads that were slightly out-of-the-money.

The VIX (volatility indicator) then reared its head. It hit an RSI level that has preceeded dramatic and near-term rallies. This gave us additional confidence to continue with (and expand) our purchases.

After the close on Thursday, we made available a chart we had been watching closely. The blue trend line had formed over the past seven months during each near-term pullback. They happened to form just as price reached the lower bollinger band. The bounce off this level further supported our analysis that a near-term bottom was in.

We also took another look at the NYMO after the close on Thursday. It had moved up to -40 (from -107). Historically, after becoming as overextended to the downside as it had, the NYMO typically moves up to the +25 to +50 levels within 1-2 weeks. We still expect significant upside in the markets, which may likely re-test the recent highs.

During the trading session on Friday, we closed a majority of our SPY call spread positions after an overnight 30% gain. That was the easy money, and we kept coming back to our favorite investing phrase: “I made all my money by selling too early.” The indices are becoming slightly overbought (not a reason to short, just a reason to pare long positions). We will likely add new long positions on any pullbacks over the coming week.


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.


December 30, 2012 (9:30 am)

During the middle of Friday’s trading session, we posted the chart below (which we’ve since updated) and explained that there should at least be a re-test of that upward sloping trend line before a true trend reversal takes place.

SPY Push Up

While we do still expect a rebound, it will likely be a good opportunity to get out of long positions and into some shorts. The SPY pulled back $5.00 non-stop, meaning the downward momentum is strong. It looks like we’re still on the first leg down. After a moderate rebound, it would be surprising if a second leg down did not develop.

Bearish Indicators

Two important things stand out when looking at the chart. The first is that the highs formed before this most recent pullback were very likely a re-test of the highs from early October. You see this pattern develop often over the intermediate-term charts. It tends to be a bearish signal that is similar in concept to a double top reversal. Not only did the market fail to break above the previous high, but it failed to even reach the same level. That’s when you see the bears attempt to take over and drive the shares down.

The second is that we never re-tested the lows put in during mid-November. The chart below illustrates the rising channel (blue trend lines) formed after the November 16 low. The market formed a V-recovery, which is a path it doesn’t often take. You tend to see a re-test of the highs or lows before a successful reversal.

Since we’ve now broken down from that rising channel, we may be on the brink of re-testing the November lows over the coming weeks due to (a) the failed re-test of the October highs, (b) the strong down momentum, and (c) the fact that we haven’t yet attempted to test the lows.

SPY Rising Channel

Double Top Target Fulfilled and Nearing Oversold Conditions

The chart below depicts the double top we illustrated a week ago Friday, when we mentioned the development of this potential pattern could throw our near-term bullish expectations out the window. This pattern has now been completed, having met the price target on Thursday. Now the SPY is nearing oversold conditions. It will need to clear those oversold conditions during a rebound before establishing a more sustainable downtrend.

SPY Double Top

Volatility Indicator (VIX) Signals Potential Near-Term Rebound

So, while we now expect a bearish downtrend to continue in the intermediate term, the near-term is a bit more bullish-biased. The VIX has closed above its upper Bollinger Band for multiple days in a row. This could be the sign of a near-term top on the VIX, which tends to correlate with a rebound in the markets. The VIX is also at an RSI level that has typically preceded near-term rebounds. The bottom of the chart below uses colored arrows to illustrate the significant of this buy signal, which has successfully called a near-term bottom in 9 out of last 11 cases.

VIX

What This Means for Apple

Apple is still trading within an enormous falling wedge. You can see in the chart below that this pattern is contracting very quickly. While Apple can fall to $499 and remain within this pattern, we’ve recently become very accustomed to seeing false breakdowns and breakouts with shares of Apple. A false break happens when a clear-cut chart pattern breaks one way, before reversing sharply in the other direction. It’s an accumulation strategy for market makers and fund managers by allowing them to take out the “stops” of other traders and investors.

AAPL Falling Wedge

It wouldn’t come as a big surprise if, during a steep sell-off in the markets, shares of Apple fell into the high $400’s. This would come a few weeks before they’re scheduled to announce earnings. A breakdown of this pattern would allow fund managers and the “smart” money to accumulate massive positions heading into Apple’s best seasonal quarter while the shares are down 25%+ from its recent highs. Whether the shares hold $500 or not in the very near-term doesn’t really impact the long-term fundamentals for the stock. While the short-term is determined by sentiment and technical factors, the strong fundamental story will drive share growth over the intermediate- and longer-term.

Previous Apple Corrections

In early November, Horace Dediu, the author of asymco.com (highly recommended), posted an article entitled “On Not Being Boring: A Dramatic Reading of Apple’s Share Price.”

The article included two important concepts. The first was that of the duration of Apple corrections. In the chart posted below from his site, duration (in days) is represented on the right, and the rate of decline on the left. The longest Apple correction lasted 150 days, and the second longest lasted 120 days. The current correction is now in third place at 100 days. It will soon end.

The second concept, which was most interesting to me, was attempting to find consistency in Apple’s sell-offs.

“Is the pattern of share price collapse actually rooted in some fundamentals, transient or otherwise? There is a clear failure in understanding the long term but were these downdrafts justified as the market “foresaw” or “discounted” the near future? Were these more than just crises of confidence? Was there wisdom in the drops because they were followed by earnings drops or slowing growth? In other words, if there was smoke, was there fire? Was the market being efficient?

No.

The graph below shows the share price change in the more recent episodes above and the earnings growth during the current and following quarters.

At least since the iPhone launched, every dramatic drop in share price was followed by a surge in earnings growth. One could even say the worse the bear, the better the growth.

Sounds completely counter-intuitive, but there is some perverse logic in this as well. The market reflects crises (as well as over-abundance) of confidence. Unforeseen growth is what creates wealth and the crisis in confidence is a reflection of the improbability of continuing out-performance. When Apple’s performance is foreseeable the stock moves slowly upward. When its performance is unforeseeable the stock moves dramatically downward.

A pithy way of putting it is: No news is good news. Good news is bad news.

When a product is understood the stock is mildly desirable. When a new product appears the future is hazy and the stock is undesirable. But that haziness hides potential but up and down. New products is what innovators produce. Bizarre new products is what disruptors produce.

In other words, the paradoxical observation in the chart above of “the more drama in the market, the more success in the marketplace” makes sense when inverted.

For disruptive companies, it should be “the more success in the marketplace, the more drama in the market.” In that sense the current downdraft may be quite auspicious.”


Good News on the Fiscal Cliff?

December 28, 2012 (12:30 pm)

Here’s an update on where we stand with the current market. Fiscal cliff rumors have created tremendous volatility in the market. I love this environment, since it brings the technicals to extremes. And those extremes allow great entry points for quick swing trades, which we’ve taken advantage of over the past few days. The evidence below points to a rebound in the SPY. Are these technical indicators foreshadowing good news on the fiscal cliff discussions?

Coming Off Oversold RSI

Yesterday, the 60 minute RSI dropped to a 23. The red line on the chart below illustrates this level, and each arrow points to the instances where the RSI dropped to that level. If you look at each instance, it corresponded to an immediate $1.50+ gain on the SPY. That’s why we were comfortable going all in with the SPY portfolio at that level and riding the $1.50 gain that came just hours later

SPY IHS RSI

If you’re curious, there are four other important patterns on the chart above.

  1. The head and shoulders pattern (green) toward the left side had a price target of approximately $138, which was met and exceeded.
  2. The falling wedge (blue) in the middle had a target move of $5 ($145 top to $140 first bottom). The wedge saw a false breakdown with capitulation, which then reversed to the upside. The price target from where it broke out was $144.50, which has since been met.
  3. The inverted head and shoulders pattern (green) toward the bottom right had a price target of $143, which was also met and exceeded.
  4. The last pattern is the rising channel (blue) on the right side. We’ve since broken down. We’ll explain our thoughts on this below

Rising Channel

The chart below shows the top trend line from the rising channel since mid-November. You’ll notice that we hit the top trend line four time in a row, establishing a higher high on each touch. Typically, before you see a strong reversal, the shares should attempt and fail to re-test that trend line. We have not yet had a re-test, which is why we took an additional position (3,500 shares) of SPY this morning at $140.55. Only after a re-test and a failure to touch the trend line should the shares see a reversal to the downside.

SPY 3 Push Up

Volatility (VIX)

The VIX chart below shows that volatility has recently spiked. It has opened and closed several days in a row above the upper Bollinger Band. This has typically called the top in volatility, which tends to correspond with a near-term bottom in the markets. Further, the RSI at the top of the chart is extremely high. The red vertical lines show the previous instances of the VIX RSI hitting the 70 level. Each has been the volatility top and preceded a rally in the SPY (which is shown at the bottom of the chart).

VIX

Buy SPY on 4 Consecutive Down Days

Lastly, I got the following chart from Cobra’s Market View. Each arrow points to the fourth down day in a row on the SPY. Green arrows mean that buying at the close on the fourth day was the absolute bottom. Blue arrows mean that it was close to the bottom. Red means that there was more down to come. If the SPY does close down today, chances are extremely high that we’ll see a rally in the coming days.

Cobra SPX