Nortel - Something To Look At?

12/23/03 10:08:00 AM

by Koos van der Merwe

The period before Christmas, especially when Christmas falls on a week day, means days of low volume and much volatility as traders take profits before the long weekend, and mutual funds adjust their portfolios to "pretty-pretty" the picture of their holdings before year's end. This provides an opportunity for the wide awake, medium- to long-term investor to find bargains.

Security: (CA)NT
Position: Accumulate

One such bargain could be an old favorite, Nortel. Let's see what the charts say.

On September 27, 2002, Nortel reached the climax of an inverted head and shoulder formation. When Nortel broke the neckline on November 20th, its target was $3.82 (2.26 - 0.70 = 1.56 + 2.26 = 3.82). On December 2, 2002, the price reached $3.65 before falling back to $2.37. Most investors would have been taken out by a rising stop and been happy with a comfortable profit. All the indicators had fallen into line with a sell signal.

Then, however, the price reversed and rose to $4.15 by January 24, 2003. Investors would have remained out of the share because of the diversification sell signal given by the RSI indicator. Speculators may have taken the risk as the price broke above $3.65, the high of December 2nd, to scalp a few cents. From January 24th, the price then fell into what turned out to be a flag formation. Investors waited for a buy signal as the price broke out of the flag on March 18th, and if they bought, would have immediately regretted their decision as the price fell back to form a triple bottom at $2.97.

Graphic provided by: AdvancedGET.

Triple bottoms are formidable support levels, and with the RSI indicator trending up, an astute investor prepared to take the risk may have bought at this price, or perhaps preferred to wait until a JM buy signal had been given (a JM buy signal is given when the price breaks above the upper band of the JM band, a 15 period simple moving average offset by 2% up and down). They would have calculated a target of $4.57 (4.15 - 2.37 = 1.78 + 2.97 = 4.57). Once again they would have been taken out by a rising stop as the price fell back after reaching a high of $4.41.

Traders would have then watched the share as it formed a triangle and happy with the success of their previous venture on patterns, would have bought as the price broke out of the triangle at $4.30. The target would be $5.74 (4.41 - 2.97 = 1.44 + 4.30 = 5.74). Once again they would have been taken out on a rising stop as the price fell rather dramatically after reaching $6.26.

What now? Well, looking at the chart, the price appears to be once again forming a flag pattern. Should a breakout occur at $6.19, the target would be $7.89 (6.26 - 3.62 = 2.64 + 5.25 = 7.89), and would give a profit of $1.70. With a stop-loss on entry of 10% at $5.58 our loss will be $0.61. Using my risk/reward ratio of 2.5 :1, this gives a profit target of $1.52. The reward on the buy therefore would be worth the risk.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.