The Oldest Country in Europe is Breaking Out

Did you know that Portugal has had the same defined borders since 1139, making it the oldest nation-state in Europe? I didn’t either and knowing that fact is probably not going to make you money but the Portugal stock market just might if you play the chart right. After more than 3 years and an almost 50% decline in its stock market it looks as if Portugal is setting an attempt to reverse course.

The chart is a technicians dream as it has set up perfectly for a move higher.

1.      Multiple periods of positive momentum divergence have formed, the latest at its lowest price

2.      Price is currently above the 200 day moving average which has flattened and just begun to have a positive slope.

3.      Price has formed 2-higher highs and 1- higher low.

4.      Price broke above important resistance (blue horizontal line) with conviction (big candle)

5.      The breakout in 4 above was confirmed on more than 5x volume as seen in the lower pane (normally look for 30-50% increased volume as confirmation)

6.      Price is breaking out of a consolidation base of 6 months or more (period under blue horizontal)

You might be wondering as attractive as this set up is why I won’t be adding it to client portfolios. Unfortunately even if we were to only take a small position (say 2%) in each client portfolio that purchase would constitute more than 50% of daily market volume, making our clients “the” market. An amount more than 5% violates our investing rules so anyone reading who is managing their own money, consider this a freebie idea. I hope you make a ton!

March 2017 Charts on the Move Video

The quarter went in like a lion and out like a lamb.  A quick look back at Q1 market action and a deeper look at momentum divergences and how they can help your investing can be viewed in my latest video at the link below

https://youtu.be/reXa5MLO1Hk

The Jaws of Death

Megaphone patterns are highly unreliable, provide little to no edge greater than a coin flip and because of the nature of their shape (expanding swings between tops and bottoms) are miserable to try and profit from. Someone, somewhere once tagged them the “Jaws of Death” because if prices do breakdown, it’s usually a doozy of a decline. Plus, it wouldn’t sell many fear newsletters (like this writer was trying to do) if you called it something like “Baby Steps Lower” now would it?

Because of the megaphone’s undependability, I don’t use them to help manage risk as I would with other patterns. But that does not mean I ignore their message. I borrowed the Dow Jones Industrials chart below from one of my mentors, one of the greatest traders ever (profits >43% per year for more than 23 years) Peter Brandt.  For those wondering, the reason the DJIA is being used rather than the broader index is because of the desire to show as much history as possible. The DJIA goes back to 1896 while the SP500 index only goes back to 1957. What should jump out at you is the DJIA has broken out ABOVE the current megaphone pattern (Jaws of Life anyone?) and projects to an upside target greater than 28000.

In spite of the negative fundamentals, political strife and radical changes going on in the world, we need to be open to the possibility that stocks can move substantially higher. That’s the beauty of technical analysis. We don’t focus on the whys but rather just price movement. The whys aren’t fully understood until much, much later and typically after the chance to profit has come and gone. It’s all about making money, not about being right.

Why Fundamentals Don’t Matter (until they do)

I often get questions about a company’s fundamental analysis. In my experience, fundamentals are of little value on their own. Oh, don’t get me wrong they do matter, but because they are a horrid timing tool, their most value is realized when looking in the rear view mirror. A good example is this year’s best performing stock, PLSE (up a trivial 320%). PLSE has no revenue, no profits and nothing from every other fundamental metric. As such, it would never show up on any fundamental screens that identified strong companies and would likely be missed by investors. That is unless they also (or instead) used technical analysis.

One common element to finding these “runners” is they will almost always start with a long basing period in which the stock price does nothing but chop around and go sideways. This action drives the bulls away and some of the bears eventually give up out of boredom.  The few that remain are the fuel to create a short squeeze driving buying volume higher acting as the impetus for a strong breakout. Like the basing pattern, volume is also clear when looking at a chart.

Taking a look at the PLSE chart below, we can see price chopped around sideways for about 20 weeks forming a rounded bottom. Price broke out from the blue horizontal resistance on light volume, fell back and retested that same line and then catapulted upward, pushed dramatically higher on more than 20 times the prior average volume.

This is a textbook example of accumulation. Prices can only rocket higher when the BIG guys (institutions) step in and buy. The good news for us little guys is that the BIG GUYS leave trails, not unlike when you are tracking elephants. In the case of institutions, we see their trails in volume patterns.

While this topic is one for another post, the opposite is true too in times of distribution. When the BIG GUYS begin to sell their shares, a topping pattern is typically formed and the elephant’s droppings are visible in the form of large selling volume.  Since it has been before Moses parted the Red Sea that we have seen distribution in the stock market, you are just going to have to believe me on this.

Divergent Warning Signs Abound

Earning season is almost over and the market is entering into a seasonally weak period without any upcoming catalysts. Combining this with weakness in breadth and lack of leadership names points to the potential for a pullback. Market weakness is nothing new as I have mentioned for a few weeks how the US stock market is overbought and looks as if a short-term pullback is likely in the cards. Across virtually every strong sector, divergent high, rising wedges have formed. While these patterns are typically bearish and resolve to the downside, there are no guarantees since only 69% actually play out. This means sticking my neck out on the line on this warning of a potential s/t correction gives me a 31% chance of it getting chopped off. I’d love to have better odds but hey, it is only a warning.

A good example is that of the financial sector ETF, XLF, the big sector winner since the “Trump bump” rally. You can see in the chart below, a textbook 5-point rising wedge formed with the 4th point forming a divergent high. Since that high, price has consolidated sideways but with a downward bias and more importantly sits right on an essential support line. If the market wants to correct as the chart is warning, a break below current support provides a target below at the T1 level.  Since corrections can typically be quick, strong moves, if T1 fails to hold then the T2 area is where I would expect any downside to terminate.

Those not long financials and have sideline cash awaiting a pullback to enter, may find this potential near-term correction a compelling buying opportunity.  If we don’t see a correction, chalk it up to the underlying strength and conviction of the bulls as they are clearly in charge.