Thursday, June 12, 2008

Chart Education, Part 1 ~ EEDT (Eve Eve Double Top) ***Updated 6/18/08***


Well, I cracked open my Encyclopedia of Chart Patterns and quickly realized that this is going to be one of the best investments I have made to my career as a day trader. I heard about the book on Mike Anthony's Extreme Stock Charts message board at Ihub.

The book is a very comprehensive analysis of the different chart patterns that can show up in your stock charts. I have been flipping FWLT calls for awhile now, and just before receiving the book I noticed that a double top was starting to form. Because these calls are one of my largest positions I decided after reading through the first chapter to skip ahead and read about double tops. There are several different types of double tops. The one that I am seeing in FWLT is a called an Eve & Eve double top.

*****Identification: First of all, by definition a double top would imply that the price trend leading up to the pattern needs to be upward. 65% of twin peak patterns studded climb away from the pattern rather than dropping below the confirmation line. Tops should look similar. Valley between can vary, normally 10-20% difference. Tops should be similar price, 0-3% variance. Peaks separation generally 2 to 6 weeks apart. Lastly, confirmation must be met to be called a true EEDT pattern.

*****Confirmation: Price must close below the lowest low of the pattern valley.

Once you have confirmed that you have a EEDT you will want to determine your target price to decide how you want to play the pattern. Rule of thumb is to measure the distance between the highest and lowest pps between the peak and valley. Take that number and divide it by two. Subtract that from the confirmation price (lowest price per share of valley) and you have your target. This calculation works 73% of the time in a bull market, and 76% of the time in a bear market.

You can play the downside on this pattern, but playing the upside once the trend changes can also be very profitable. Also, as noted above 65% of twin peaks do not confirm, and price will rise on average 70% when the pattern busts out.

The information above is paraphrased from Encyclopedia of Chart Patterns.

Now, lets evaluate our FWLT chart.

Click on chart to enlarge.


Note: This chart was created during the trading day.

The first thing that you will notice with the chart above is that yes, we have an upward trending stock price leading up to our pattern. Our two peaks are similar in appearance, rounded at the top. The peaks are almost three weeks apart (12 candles, plus 7 weekend and holiday days), so our time frame is correct. The left peak (highest) is at 79.82 and the right peak is at 79.29. that difference of 0.58 is less than 1% difference, which is within our 0-3% variance. The valley low price is 71.36, which becomes our confirmation number. Valley is 10.6% of peak price, which is within the 10-20% norm for peak to valley difference. Today we closed at 70.82 which confirms our pattern.

Since our pattern has confirmed, our next step is to do the calculation that will give us our price target for the down trend.

(79.82-71.36) / 2 = 8.46 / 2 = 4.23
71.36 - 4.23 = 67.13

Based on this calculation 67.13 is our price target. One play would be to purchase some puts tomorrow morning at open. While I will probably do a paper play on this just to get a feel for playing this chart pattern, there are many reasons why I would not make this play. First of all, option expiration is next week, which exasperates time loss on option plays exponentially. Secondly the price difference from confirmation to target is fairly small. The difference is only a little over 5%. Since I try not to purchase options the first 30 minutes that the market is open, chances are that percentage will be greatly diminished before I was able to purchase the option. Finally there are several levels of resistance that FWLT would have to push through in order to achieve that 67.13 price target. On 5/12/08 the price of FWLT gapped up from 69.65. There is a possibility that this decline is just an effort to fill that gap before continuing the upward price trend. Next, the price has closed at support of 70.98 this is a very strong support (variance 1.99) for FWLT. The support level has been tested more than 3 times, with high volume and held. We also have the 50 and 200 day moving averages within that support variance at 69.45 and 68.98 respectively. This is going to be a ripe spot for mutual fund managers to pick this stock up for a run up.

Because of these strong support levels, and the huge upside potential I have decided that my play is to start making equity purchases of FWLT. I made a small purchase at 71.56 today, and may add to that if it dips to the target of 67.13 or below.

Update 6/13/08

"One play would be to purchase some puts tomorrow morning at open. While I will probably do a paper play on this just to get a feel for playing this chart pattern, there are many reasons why I would not make this play."

I did not even make this play on paper. FWLT gapped up from Thursdays close of 70.98 to open at 71.70.

"Because of these strong support levels, and the huge upside potential I have decided that my play is to start making equity purchases of FWLT. I made a small purchase at 71.56 today, and may add to that if it dips to the target of 67.13 or below."

I purchased about 1/2 of the position I was willing to carry on FWLT at 71.56. My target is 85.00. I will need to watch for resistance at 80, to see if FWLT is able to push through, or if a triple top forms. I also need to watch that it doesn't close below our confirmation line at 71.36.

The chart below lays out a few trend and support / resistance lines, which give an idea of where my targets and watch areas are coming from. Our close yesterday came close, but did not quite fill the gap on 5/12 from 69.65. 85 seems like a reasonable target which will net us approximately 18.75% profit on the trade. I may bank some profits at the 80 level though if it has too tough of a time breaking that resistance. Even to 80 we can net a 11.75% return on this trade.


Click on chart to enlarge.


Update 6/14/08

Before I start my analysis of a few other stock charts, I wanted to review a couple different time frames on FWLT. In the first chart, we are looking at a 10 day chart at 10 minute intervals. As you can see FWLT has broken out of it's downward trend.


Click on chart to enlarge.



Looking at FWLT's 2 year chart, you can see a similar double top failure around this same May-June time frame.

Click on chart to enlarge.



Assuming a purchase of around 51.50 when the chart pattern failed to confirm, to the top of the run completed during the first half of July, the stock priced gained 20.3%.


Update 6/16/08

The stock performed pretty much as expected today, making another leg up. We may meet some resistance here at 76.43, and I will be surprised if we touch 80 before option expiration, though it is possible.


Click on chart to enlarge.


Update 6/17/08

The stock closed with a red candle today, but above 75. Volume was low, about 45% of the average volume for the past 6 months. We are still in the upward moving channel, but I will be watching this one close tomorrow. A close under 75 could indicate that this was just a pull back on the double top formation, and there is more down side to be seen on this stock.

Click on chart to enlarge.




Update 6/18/08

The stock closed today with a white spinning top, which signals indecision in the market. I am expecting the stock to stay under $75 through option expiration on Friday. I will hold my current position, but would not suggest buying or shorting this stock at this point, it can still go either way.

Click on chart to enlarge.



Always perform your own due diligence before making any investment.

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