Blockbuster's Bullbusting Divergences

12/21/04 10:49:16 AM

by David Penn

Up strongly over the past month, shares of Blockbuster have joined the broader market in warning of lower levels.

Security: BBI
Position: N/A

When Blockbuster Video announced a few weeks ago that it would be ending its policy of demanding late fees for materials tardily returned, everyone who wasn't already subscribing to competitor Netflix likely rejoiced. I know I did, even if it meant that my overdue copy of the "Ultimate Fighting Championship: PAYBACK" would still cost me an arm and a leg when I finally got around to returning it.

But there might have been bad news in that rental announcement. For in ending its late-fees policy, Blockbuster not only signaled to competitors like Netflix that its model was superior, but also that Blockbuster itself was warning that a major source of revenue--that is, the late fee--was about to become a thing of the past. How that revenue would be replaced is anyone's--and especially any shareholder's--best guess.

Figure 1: Blockbuster. Two higher highs in early December and again near mid-month are matched by two lower highs in the 7,10 stochastic. Note also that BBI is at the upper boundary of a fairly steep trend channel.

Graphic provided by: Prophet Financial, Inc.

Blockbuster made its late-fees announcement on December 14. That day, shares that had been pulling back for the past trading week or so finally bottomed and began moving higher. You can see how the pullback and the December 14th bottom both found support on the 10-day exponential moving average (EMA). The 10-day EMA (and similar short-term moving averages like the five, nine, and 13) are excellent gauges of the strength of the short-term trend. In the final chapter of his book, PIT BULL, trader and Market Wizard Marty Schwartz writes:

The ten-day exponential moving average (EMA) is my favorite indicator to determine the major trend ... [The EMA] is much more sensitive to the last data point, crucial for a short-term trader. I call this "red light, green light" because it is imperative in trading to remain on the correct side of the moving average to give yourself the best probability of success.

Schwartz added his own wrinkles to the 10-day EMA, but his point remains broadly applicable.

So, shares of Blockbuster would be in "green light" mode as of the close on Monday, December 20. This would suggest they could be bought. But is that the same thing as saying that they should be bought?

What worries me about Blockbuster is the same thing that worried me about the Nasdaq (see my upcoming Traders.com Advantage article, "Nasdaq Near Confirmation Of Its Negative Divergence--Again"). Namely, my concern is that the Nasdaq and an uncomfortable number of stocks have made multiple higher highs in price, with simultaneously multiple lower highs in the 7, 10 stochastic oscillator.

As I have written before and will note again: Divergences are not uncommon in strongly trending markets. Nevertheless, divergences can be excellent signals to enjoin or abandon trades (a perfect example of "enjoining" is discussed in my Traders.com Advantage article, "Divergences And The Bush Bounce," from November 9, 2004). As such, I think the divergences in Blockbuster--as well as in other stocks and averages--are worth paying attention to, if not heeded outright.

David Penn

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

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Blockbuster's Bullbusting Divergences

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