Will This Historically Bullish Setup Send Stocks Higher?

While stocks finished trading on Wednesday higher by 1.75%, we still saw an increase in the number of stocks making new 52-week lows on the NYSE. At first glance I thought this was another sign of deteriorating breadth, with fewer stocks participating in the advance. Not to say this is not true or to take away from the notion that breadth has been weakening over the last several weeks, but historically this setup has been short-term bullish for equities.

To look at things further I put the data in excel and ran the numbers. Below is a chart that shows past instances of the number of new 52-week lows on the NYSE rising, the S&P 500 ($SPX) closing with a gain of at least 0.80%, and the percentage of NYSE issues making a new 52-week low being greater than 7% going back to 1990. It’s rather common for the number of new 52-week lows to increase while stocks rise, but it’s rather rare to see this occur with a large percentage of stocks.

As you can see, when these three criteria are met, we have historically had a short-term bottom in stocks. The last example of this happening was in 2011 and before that was at the 2009 low. When looking at the data it’s hard to ignore the instances where these measures lined up before the 2000 and 2007 highs. So it is not to say that we won’t have lower prices, as there are many pieces of data right now that could help make that argument. However, we may be seeing some exhaustive selling that could allow equity bulls some reprieve.

If we were to tighten up the criteria to the S&P 500 having a gain of greater than 1.75%, like we saw on Wednesday then the number of previous occurrences gets cut from 24 down to 7, with the last four occasions being March 3, 2009, September 2008, and October 1999.

Indicator

Data courtesy of stockcharts.com

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Head & Shoulders Pattern in Small Caps

There seems to be a lot of discussion about the current bearish pattern that’s taking place in the Russell 2000 ($IWM). While there are likely tens if not hundreds of price patterns found throughout technical analysis, few are as popular or often discussed as the Head & Shoulders pattern. There is good reason for is this as it has lead to some major declines in financial markets. For example there was a Head & Shoulders pattern that lead to the peak in the Dow back in 2007.

Should we be concerned about this bearish pattern? Does it hold any relevance? One good resource is thepatternsite.com, which does a great job looking at the data of varies candlestick and price patterns. According to Bulkowski’s analysis, the Head & Shoulder pattern ranks number 1 among 21 well-known pricing patterns. This is based on the 4% failure rate and 22% average decline calculated by Thomas Bulkowski.

So it appears we may have good reason to take these types of setups seriously, so what defines a Head & Shoulders top? There are few better resources to turn to than Robert Edwards and John Magee’s, Technical Analysis of Stock Trends – often considered the bible of Technical Analysis. Edwards and Magee seem to agree with Bulkowski stating in their book, “This [the Head & Shoulders] is one of the more common, and by all odds, the most reliable of the major Reversal Patterns.”

They continue in their writing to define what they believe is the “ideal” Head & Shoulders top:

A. A strong rally, climaxing a more or less extensive advance, on which trading volume becomes very heavy.

B. Another high-volume advance which reaches a higher level than the top of the left shoulder, and then another reaction on less volume which takes price down to somewhere near the bottom level of the preceding recession.

C. A third rally, but this time on decidedly less volume than accompanied the formation of either the left shoulder or the head, which falls to reach the high of the head before another decline sets in.

D. Finally, decline of price in this third recession down through a line (the “neckline”) drawn across the Bottoms of the reactions between the left shoulder and head, and the head and right shoulder, respectively and a close below that line by an amount approximately equivalent to 3% of the stock’s market price. This it he “confirmation” or “breakout.”

We now know what we are looking for with respect to the bearish reversal pattern in $IWM. Now lets see if the latest price action meets the above mentioned criteria. Below is a daily chart of the iShares Russell 2000 ETF ($IWM). I’ve marked the two shoulders and the head as well as the horizontal neckline at $108.

In the bottom panel we can see that volume has been declining with the formation of the head and right shoulder. Based on the work done by Edwards and Magee, we would need to see a breakdown to roughly $104.76, which would be 3% under the neckline. Volume on the break can also be an important ‘tell’ as bears will be looking for a strong move on heavy volume to help confirm and complete the pattern.

IWMWith this type of pattern we can calculate the expected measured move by looking at the distance from the head of the pattern to the neckline. This would take us nearly 10% low down to $98. However, it’s important to note as Bulkowski stated, only 55% of the patterns actually complete their expected measured move.

While these types of patterns garner much attention nothing matters until the neckline is broken, which Edwards and Magee point out that roughly 20% of necklines are “saved,” meaning the pattern is not 100% completed. Going forward I’ll be watching the $108 level and see if we get a break on heavily volume and if price is able to drop to $104 to confirm the move is not in fact a false breakdown. But until then we must be a patient.

Source: Technical Analysis of Stock Trends by Robert D. Edwards and John Magee (ninth edition)
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Is Natural Gas About to Breakout?

Natural gas has been in a period of consolidation for the last two months. However, it appears we may be getting ready for a breakout based on the recent price action, bullish COT data, seasonality and positive divergences that are currently taking place in the nat gas market.

Below is a chart of the United States Natural Gas Fund ($UNG) going back the last nearly ten months. After the 22% drop from the last high made in June, price has been trading in a fairly tight range. This type of consolidation can produce some large moves as if it were a coil that was being pushed together. While this consolidation has been taking place, the Relative Strength Index has been putting in a series of higher lows. This bullish divergence has also led to the RSI making a higher high after Monday’s close.

In the bottom panel of the chart we have the On Balance Volume Indicator which simply adds the volume on positive days and subtracts the amount of shares traded on negative days. This tool can help us see if there is a bias towards buying or selling. Since the indicator has been rising its July low, we know that more shares have been traded when $UNG has been advancing compared to when it has been falling – a positive sign for nat gas bulls.

We’ll see if these bullish indicators of momentum and volume lead to price breaking above its August high.

UNG

Commitment of Traders 

The next chart I want to show is of the Commitment of Traders (COT) data for Natural Gas. The red line in the bottom panel of the chart shows the Commercial Traders, which are often company’s that deal with natural gas within their own business, so they are often considered the ‘smart money’ within a market. After going net-short the commodity earlier this year right before price peaked, the Commercial Traders have been slowing building back their net-position towards a historically high level. Even during this period of consolidation, the ‘smart money’ appears to have been picking up contracts in Natural Gas.

Nat gas COT

Seasonality

This final chart comes from Signal Financial Group and shows the 10-year seasonal trend for Natural Gas. Interestingly enough, the 5-, 10-, 15-, and 20-year seasonal trends all mirror one another, which in my opinion helps re-enforce the significance of this seasonal pattern. Like we have seen somewhat this year, price has put in a low in early September while showing slight strength during the last month. What catches my attention with this seasonal study is the large move towards the end of October that crates the historical first point of a double top before price has weakened into year-end and the first few months of the following year.

Nat gas seasonality

So it appears we have price getting ready to breakout of its two month consolidation. While at the same time momentum and volume are creating bullish divergences and the ‘smart money’ has been increasing their net-long position in Natural Gas based on COT data.

(At the time of this writing my firm holds shares of UNG in certain client accounts and may sell those holdings at any time. However, this is not a recommendation to buy or sell UNG, other natural gas-related or any investment vehicle.)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.