Perfect Flag Example

Oct 31, 2007: 6:37 PM CST

The Chicago Mercantile Exchange (CME) stock recently carved out a near-perfect technical analysis ‘flag’ pattern formation that can be used as an example for further study.

Remember, a flag is proceeded by a sharp price and momentum impulse, consolidates for (usually) less than two weeks, and then ejects upwards in a ‘measured move’ that allows proper (or possible) price projection.

The “pole” of the flag serves as a measuring rule when price ejects from the flag. The best flags will be contained (price will find support) at a rising 20 period moving average.

Let’s look at the perfection of the recent CME action:

The test of the rising 20 period MA served also as an “Impulse Buy” trade due to the new momentum high preceding it. This is common of observed flag formations.

The initial flag pole began around $540 and terminated around $620, carving out an $80 price move. The breakout from the flag at $620 could have allowed for a price projection $620 + $80 = $700.

Price reached its recent high around $695, but the projections were based on rough calculations and fell $5 shy of the projected target (still an amazing and impressive run).
Had you calculated the projection from the bottom of the flag – at $610 (at the moving average), then the objective was met and exceeded by $5. Either way, a $70 – $80 potential target that was achieved in 5 days is nothing less than absolutely stellar.

Flags are often easy to perceive on a chart and are relatively easy to trade. Study them further if you aren’t quite sure what they are or how to trade them.


Housing – Why All the Huffing and Puffing?

Oct 31, 2007: 1:20 AM CST

Analyst Sam Stovall wrote a most insightful article regarding brief historical lessons regarding past housing contraction cycles and resultant recessions. The article from Business Week is entitled, “Housing… Why All the Huffing and Puffing?”

While the entire article is certainly worth reading in detail, here are some key highlights:

“We think increased investor concerns… could be related to history lessons, which show a high correlation between declines in residential construction and recessions…. Every recession since 1960 has been accompanied by a year-over-year decline in residential construction….”

“Though all recessions have been accompanied by construction declines, not all construction declines resulted in recessions.”

“Wyss pegs the likelihood of a recession at 33%, and the reason we don’t expect this to happen is due to the breadth of the overall economy and foreign investors’ interest in a weakening dollar and the dollar’s positive impact on export demand. We also expect a proactive Fed and Treasury Department to get ahead of a recession curve.”

The author notes the positive impact that the dismal decline in the US Dollar Index will have on exports. Recall that cheaper (relative) dollars make foreign exports more attractive, meaning more sales for US companies. A falling dollar is not nearly as negative as some writers would have you believe.

Refer to the entire article for complete insights. Stovall conjectures that, although the housing decline is devastating, it will not crush the overall economy because of other forces, including a pro-active Federal Reserve and increased exports due to the falling dollar.


Platinum and Oil Charts

Oct 30, 2007: 11:32 PM CST

Per recent reader request, here is a brief swing chart or divergence look at the Platinum and Oil charts:

(Chart: TradeStation)

Jonathan correctly identified a developing momentum divergence forming on the daily futures chart for Platinum.

The last ’swing high’ took place at $1,400 and then now we made new price highs at $1,475 and are now retracing nicely to the rising 20 period exponential moving average.

When we spot a divergence in price (with the blue momentum oscillator), then odds favor a resolution of the divergence in favor of the oscillator, using the principle “Momentum Leads Price Action.” The initial target would be a retracement to the 20 period moving average as the first line of – in this case – support. Entering a momentum divergence trade is often psychologically difficult, and you need to utilize absolute and close stops because the trade is – by nature – a counter-trend trade.

Price may be so strong in this case that it actually fails to retrace to the EMA, but more than not, momentum divergences are resolved and terminated at or through that boundary.

Divergences do NOT signal trend reversals, but only that – in this case – buyers are ‘losing steam’ as they try to push price higher. Momentum divergences are often the result of the prior swing being less forceful than previous price swings.

For those who follow concepts set forth by Linda Raschke, a “Holy Grail Buy” may be setting up in this contract because the lowest pane indicator is a standard ADX (Average Directional Index) that is set to trigger red when it crosses above the 30 threshold and trigger blue when it drops below 15. Raschke teaches that the “Holy Grail” concept occurs when the ADX increases above 30 to signal a strong trend and calls out a ‘buy’ (entry) when price retraces to its rising 20 period moving average. Technically, price has yet to do so, but traders can be on alert for it to do so should it test the moving average. Stops would go comfortably beneath the moving average.

You can recreate the ADX or moving average indicator with any popular charting software.

As a bonus, let’s look at the price of Crude Oil (futures), which has been featured frequently in the media these last few days:

I didn’t draw in the ‘divergence,’ but I think it’s actually clearer to see than Platinum or Gold (on the daily chart).

I previously mentioned the divergence setting up and we now have price correcting down off its highs in a similar manner to Platinum. Again, any pullback to the rising 20 period MA will set up the famous “Grail Buy” trade because the ADX currently stands at 35 (not shown on the chart).

Until price takes out the swing low at $85 and also makes a lower high, we still have a major uptrend in the price of oil, which can be rather bearish for the overall stock market.

Elliott Wave theorists, take note. We may have a complete three-impulse price push completing itself with Crude Oil. The chart would be a near perfect Elliott Wave pattern, except that the 1st wave was the most dynamic wave, instead of the 3rd.

Nevertheless, the chart provides evidence to the ’swing theory’ of the market – that of price moves in swings to reach balance.

We will definitely be watching other commodity prices for further signs of inflation.

With inflationary pressures sweeping most commodities, can the Federal Reserve ‘afford’ to Cut Rates this Wednesday?



Recent Links

Oct 30, 2007: 7:23 PM CST

In preparation for the Meeting of the Federal Reserve on Wednesday, why not take a look at some other insightful posts from the blog world:

Pivot Level Support and Resistance: How Often Do We Hit Those Price Targets? from Dr. Steenbarger

Wizards and Pundits – interesting post from Adam on BIDU at Daily Options Report

Commodity bull: Second phase from Smart Money Tracker

Related article from Smart Money Tracker on Inflation.

Controlling Emotions and Is There an “Emotion Switch?” both from Dr. Bruce Hong at TraderPsychology

Kevin on The Head And Shoulders Reversal Pattern

Stockbee provides specific stock possibilities in Market weakness creates opportunities in IBD 100

Try not to trade too heavily in ’speculation mode’ tomorrow with the Fed announcement unless you’ve traded such occurrences in the past.  There is a lot of potential for profit, but also increased risk if you position incorrectly.


No Stopping the Commodities

Oct 29, 2007: 8:38 PM CST

The $CRB (commodities) index made new highs, after having advanced four trading days in a row, three of which opened at the low of the day and trended up to close on the high of the day, indicating decisive strength.

Price is now at the top of the Bollinger Band after an extended move up, and so odds are starting to favor a pullback, but the trend is so strong that higher prices are likely yet to come.

Also, the lower-pane momentum oscillator is failing to confirm the new price highs, most likely because the two most recent price swings have not been as dramatic as the price swing from index level 300 to 335 from mid-August to mid-September.

Typically, a trend will get ‘three pushes’ and then consolidate. Elliott Wave lovers, this would have been a perfect 5-wave impulse were it not for the fact that the first wave (leg) was the longest wave (typically, Wave 3 should be the longest).

Let’s look at Crude Oil:

(chart courtesy TradeStation)

I’m showing the most up-to-date price for the futures contract, (as of 8:33 Central Time), and Crude Oil Futures have breached $93, coming off the intraday high of $93.68. Price is literally ‘off the chart,’ or at least off my scale.

If you look closely at the chart, you’ll notice that we have a “Measured Move” which has just played itself out, and we can perhaps expect a bit of a pullback. In addition, we are seeing the slightest momentum divergence (look at the most recent peak in the ‘blue’ oscillator – it is lower than the previous price swing peak).

Again, measured move completions and swing divergences do not indicate a change in trend, but signal a consolidation or retracement at best is ahead. I’m sure the overall market would welcome lower oil prices, but it seems like Oil at record levels (though not inflation-adjusted records) has had little real effect on the S&P 500.

This next chart of Orange Juice Futures is more for fun than for analysis:

(chart courtesy TradeStation)

I’m pointing out a pronounced momentum divergence that has resolved itself quite nicely with new price and momentum highs.

It appears that orange juice may be on a course to break its prolonged daily downtrend. To confirm a new uptrend, price would need to swing back up and trade above the $160 level to establish a higher low and then trade above the most recent swing high.

Anyway, I thought the divergence analysis would prove enjoyable to see.

In other brief news… The US Dollar Index made new lows again today… but what else is new?

If the “Fed” cuts rates as they are widely expected to do, expect new index lows to continue on the US Dollar Index.

FOREX traders, take note! Other currencies relative to the dollar – such as the Euro – are making new relative highs as the dollar index makes new lows.


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