When Technicals And Fundamentals Tangle

03/22/04 09:53:58 AM

by Matt Blackman

How many times have you seen a great technical pattern form only to watch it fall apart later? Often the reason is simple and knowing it can keep the savvy trader safe from harm.

Security: PETC
Position: N/A

Petco (PETC) recently formed a classic double top chart pattern. It hit a high of $35.85, retreated to $29.59 after which it mounted a new topside attempt. This second move made it to $34.19 before failing and gapping lower. It then broke the neckline and looked to be moving to the downside target projected by the pattern of $23.30, right? But before we pull the trigger, let's take a closer look.

Figure 1 � Daily chart of Petco Animal Supplies showing classic double top with neckline at $29.59 and target of $23.30. The green horizontal lines show that support will have to be broken to reach the target. Chart provided by www.highgrowthstock.com Data by www.Quotes-Plus.com

In a heads up from Recognia.com about a double top chart pattern that had just formed on the stock, I decided to do a little more homework. A quick check of the fundamentals showed why shorting this stock and then waiting for the target to be hit no longer seemed like such a hot idea.

First the P/E ratio at 23.7 was not all that high. For a short, I'd rather see either negative earnings or a sky-high P/E of 50 plus. Next, the earnings showed a good sequential growth rate of anywhere from 27% to 47% growth in the last four quarters. Short interest is roughly just 1% of float, well below my acceptable threshold of 5% or better to short. Insiders had sold 761,800 shares in the last three months and the price-to-book value per share was just $0.56. However, all but of the ten institutions that held the stock were buying as were most of the mutual fund companies. At a price of $28.16, it was already getting close to the first level of support at $27.15. Other than the pattern, some insider selling and a low book value, there were not a lot of good reasons to sell.

Since the fundamentals for the most part showed a strong company and strong companies make poor short candidates, I took a pass. While it may eventually hit the price target given by the double top, it would take either a major market melt or some exceptionally bad news to do so, making the trade more of a gamble. Petco looked like a better stock to put on watch list and buy at support at either $27.00 or at $25.00 if the first support line was broken on the first sign of strength.

There are traders who don't check the fundamentals, but for the five minutes it takes, those who do could save themselves a world of pain waiting for a target that has a high probability of not being reached.

SUGGESTED READING:

O'Neil, William [2002] How to Make Money in Stocks, McGraw-Hill

Using technicals and fundamentals together
http://www.highgrowthstock.com/Demos/default.htm

Price and fundamental data available
http://www.quotes-plus.com/data.htm

Some great information on identifying chart patterns
http://www.recognia.com/reference/patterndescr.htm

Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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Comments

Date:�03/24/04Rank:�2Comment:�I do not agree with this article. Fundamentals decide what to buy, technicals decide when to buy. You cannot replace one with the other. Even the best companies fundamentally become overbought and need to be shorted. And even the worst companies become oversold and need to be bought. This article seems to create a confusion rather than clarify one.

Date:�03/24/04Rank:�5Comment:�

Date:�08/04/05Rank:�5Comment:�

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When Technicals And Fundamentals Tangle

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