Is an Intermediate Term Internet Top In Place?

By now it should be easier to recognize some of the more basic price patterns that investments can develop. Because the head and shoulders top reversal is frequently brought up most by those who are least qualified to talk about them (the media), making them more recognizable, I thought I would bring to light one that just came up on my radar screen.

As you can see in the Dow Jones Internet Index below, it has formed a symmetrical head and shoulders pattern with a well formed horizontal neckline. In the favor of the bulls we can see the head did not make a divergent high but the volume patterns are what bears would prefer to see. As is almost always the case, there is a case for both bulls and bears to make. On a bigger picture view we should be leaning bullish as we know from experience that most of these patterns fail. Why? Because stocks are in uptrends most of the time and these patterns are uptrend reversals. As such, from a probability standpoint it makes sense they do fail most of the time. Of course, there are always short term corrections and pullbacks giving any topping patterns an opportunity to play out. It’s important to mention since we are looking at a daily chart, I am not speaking of a “final” top, but rather an “intermediate” top where price eventually moves on to new highs.

With all this in mind this post is not intended to cause alarm or fear or a signal to sell but rather something to learn from. I intend to come back later and post a follow up after the final outcome of this pattern has played out. The two possibilities are 1) a completion move down to T1 or below; or 2) a failure confirmed by a move back above early August’s right shoulder high (before it has completed a move to T1).

On a side note, you will find head and shoulders bottom reversal patterns (inverse head and shoulders) have a much higher probability of meeting their target. Why? For the same reason why topping patterns fail most the time. Because stocks are moving higher over the long term and you are investing with the trend.

August 2018 Charts on the Move Video

August was a barn-burner for stocks, specifically US stocks. The Nasdaq popped almost 6% and the rest of US stocks moved higher while most of the rest of the world equities fell.  Its a great time to be an investor in the current US market strength. As the pro's and big money come back from summer vacation will September follow August's lead and continue higher or will it offer something more challenging?  While we wait for this question to unfold, have a look at this months Charts on the Move video at the link below.....

https://youtu.be/6gf-MD3llM4

When Failure is Good

The are few things as short term bullish than a failed breakdown at a level of major support. The breakdown has short sellers jumping in to take advantage of a continuation of downside action. A reversal (breakdown failure) and move back above support/resistance creates upside fuel as the short sellers are forced to cover, pushing the stock higher. Depending upon the amount of shares shorted, the ongoing cover could move the stock much higher, as momentum players will eventually add more fuel as they jump on board the train higher. The thing to remember and watch is that dynamics of movement around support and resistance can lead to big moves ... in both directions

GE, a company I have lost any interest investing in, after falling more than 60% in 2 years may have found a (temporary) bottom, setting up for a reversion to the mean trade.  As you can see in the chart below, GE’s price tested the $12.75 level at least 5 times before it finally failed mid-August and began another push lower.   

As can be the case with breakdowns, price stays below support for a couple of days and reverses. GE declined 3 days, printed a hammer reversal candle and has subsequently moved higher. Yesterday it closed right on the critical support/resistance zone. A move and hold higher points to potentially much higher prices. The first target being T1 and ultimately the possibility of retesting prior 2017 highs which would provide an almost double (100% return).

Before we get lost in our dreams of a first-class trip around the world paid for with the windfall profits from a GE failed breakdown, it’s always important to frame the risks. That $12.75 area is key. A move and hold above (preferably on increased volume) is a signal to be long while a revisit and hold below, tells us to move on and put the first-class trip on hold.

Momentum

I have written about the numerous studies showing the case for momentum stocks being a core holding in your portfolio here in the blog. If you don’t know how to screen for momentum stocks or prefer not to mess with buying individual shares, there is an ETF from Ishares, MTUM.  It seeks to track the performance of an index that measures the performance of U.S. large- and mid-capitalization stocks exhibiting relatively higher momentum characteristics, before fees and expenses of course. Easy-Peasy

As you can see in the chart below, it recently began trading with enough volume for us to consider adding as a core position to client’s portfolios. I do think our entry in April was excellent as it created a wonderful pullback buying opportunity. As you can see during the consolidation that started in January, RSI momentum unwound out of overbought territory and was set up for its next push higher.  And higher we go as price broke out to new, all-time highs last week. All that is great news for MTUM holders but I just noticed the Referee pulled out the yellow caution flag. Notice how at the same time while price was making all-time highs, on balance volume (lower pane) was making a lower high. It’s not time to throw in the towel just yet as divergence can easily be wiped out and be nothing but memory roadkill if we see an increase in the number of buyers in the coming weeks. So, the bottom line is it’s not a problem …. until it is.

I know some of you are thinking what good is this technical analysis stuff. Every time I show a chart it’s never 100% clear or certain as there is always something both good and bad. Which is exactly why you 1) use a weight of the evidence approach to making an investment decision and 2) have an exit plan in case the market proves you wrong. TA is not about being right but instead about managing your risk.

Biases

Source: New York Times

Surprise! Partisan politics confuses some peoples’ ability to make objective assessments of economic data:

“Americans’ perceptions of the economy’s prospects increasingly depend more on their political identity than statistics on output or stock markets. “

Is it a cognitive issue? Of course! Salesmanship? Maybe. Bias? Definitely. But why else would the change in POTUS affect anyone’s impression of the economy improving? Is it more likely forward expectations or tribalism?

Truth be told, it really does not matter.

What does matter is this simple bottom line: your biases affect how you see the world, which in turn affects how you think about, well, everything: politics, money, the economy, and of course, your investments.

You can do your best to not allow these elements into your investing strategies, but if you are human, it is all but inevitable that cognitive errors and biases eventually show up in your portfolios . . .