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REVERSAL


Catch 1-2-3

08/13/04 02:04:21 PM
by David Penn

Yahoo (YHOO) makes a 1-2-3 trend reversal, gapping down all the way.

Security:   YHOO
Position:   N/A

The principle behind the notion of a "Catch-22" might be summed up as: damned if you do and damned if you don't. For stocks that find themselves twisting and turning in the 1-2-3 trend reversal pattern (a pattern first described by Victor Sperandeo in his very worthwhile book, Methods of a Wall Street Master), the "catch" is no less equivocal -- even if there are a few options for escape.

I've written frequently about the 1-2-3 trend reversal method, but let me briefly recap the pattern before applying it to shares of Yahoo over the past few months. Each stage in the 1-2-3 trend reversal pattern refers to a specific price action relative to either a trendline or a previous high or low. The "1" refers, for example, to the initial trendline break. The "2" in the 1-2-3 trend reversal refers to the attempt by the stock or commodity to resume the previous trend indicated by the trendline that was just broken. Finally, the "3" refers to the moment when the stock moves beyond the low (in the case of an upward trendline being broken) or the high (in the case of a downward trendline being broken) established during the initial breaking of the trendline.

Whew! Fortunately, the 1-2-3 trend reversal is far easier to spot than it is to describe succinctly in words. Here is a chart of YHOO, with the various 1, 2, and 3 points noted.


After breaking down below support at 28, YHOO had completed stage 3 of the 1-2-3 trend reversal.
Graphic provided by: Prophet Financial Systems, Inc..
 
There are a number of interesting features in this Yahoo chart. But sticking with the 1-2-3 trend reversal pattern, note first that YHOO completed stage 1 with the gap down in early June. Incidentally, this top might have been anticipated by the negative divergence between the consecutively higher peaks in the stock from late May to late June and the consecutively lower peaks in the 7, 10 stochastic.

An important pivot to note is the extent of the "post-break move." This is the extent that prices move when breaking through the trendline before reversing. This level is important because it will let you know when the final step in the 1-2-3 trendline reversal pattern, stage 3 has occurred.


Stage 2 represents the attempt by prices to resume the previous trend. Here, in the case of YHOO, that attempt appeared to stall near 31 --at the level, as it turns out, where YHOO gapped down in making stage 1. Finding resistance at that level, shares of Yahoo turned down abruptly, and within a day or two, again gapped down to new monthly lows.

And it was during this gap down that YHOO entered stage 3. YHOO gapped down early in August, but it was during the follow-up day that stage 3 actually began. Even though prices have bounced a bit from support in the 26 area, the fact that YHOO had found resistance at previous gap-down levels suggests that YHOO might once again struggle to clear the 28.25 level.


As for downside projections, the 1-2-3 trend reversal in and of itself doesn't provide any. Looking at the chart, it seems reasonable that if there is some level of temporary support at 26, then there is the possibility that, if violated again, this support level will serve as a sort of hinge. If so, I use Stan Weinstein's swing rule to take the distance from the high of the rally (about 36) to that support level at about 26, and subtract that amount from the value at the support level. In this instance, that leaves a downside target of about 16.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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