Double Bottoms and Big Caveats

05/15/03 12:41:27 PM

by Arthur Hill

Here is the Telecoms HOLDRS with a big double bottom and a big caveat.

Security: TTH
Position: N/A

Telecoms were one of the hardest hit sectors over the last few years. The Telecom HOLDRS (TTH) fell from 92.62 in Mar-00 to 20.71 in Jul-02. The downtrend was never in question as the stock formed a series of lower lows and lower highs during this time frame.

Since the Jul-02 low, the stock found support around 20.7 at least three times. In between these support bounces, the TTH forged a reaction high around 30 and a move above this high would confirm a double bottom. Based on traditional technical analysis, a move above the Jan-03 reaction high (30.51) would project further strength to around 40 (30.5 - 20.7 = 9.8, 30.5 + 9.8 = 40.3).

Figure 1: Weekly chart for the Telecom HOLDRS.

Graphic provided by: MetaStock.

RSI confirms the potential double bottom. RSI dipped below 30 in July and October, and then formed a large positive divergence over the last few months. In addition, a move above the November high would forge a bullish failure swing. According to Wilder, a bullish failure swing occurs when RSI advances from below 30, declines, forms a higher low above 30 and then advances above the prior reaction high. RSI is currently above 50 and further strength above 56 (black arrow) would complete the bullish failure swing.

There is one caveat to the double bottom scenario, and it's a big one. The pattern over the last few months could evolve into a continuation head-and-shoulders pattern. The left shoulder formed with the August high, the head with the Nov./Jan. highs and the right shoulder could be forming now. Neckline support resides at 20.7 and a move below this level would signal a continuation of the long-term downtrend. The projected decline on such a support break would also be 9.8 points.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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