Biotech Index Breaks Consolidation

01/03/05 08:04:28 AM

by Arthur Hill

After a fairly lengthy consolidation, the Amex Biotech Index broke resistance to signal a continuation higher. But how much higher?

Security: $BTK
Position: Buy

There are two types of head-and-shoulders patterns: reversal and continuation. As its name implies, a reversal pattern signals a change in direction. A bullish reversal pattern forms after a decline and a bearish reversal pattern forms after an advance. In contrast, a continuation pattern signals a move in the direction of the prior move or a continuation. In this case, the Biotech Index advanced and the inverse head-and-shoulders pattern represents a consolidation. With the breakout above neckline resistance, this consolidation has been resolved in the direction of the prior move and is therefore a continuation pattern.

Evidence of a consolidation was also apparent with the Bollinger Bands (Figure 1). These volatility-based bands expand as volatility increases and contract as volatility decreases. The bands typically contract during consolidations and expand when prices start to trend. As the Bollinger Band width indicator shows, the bands were at their lowest in many months, and this represented a consolidation. The move above the upper band signals a bullish resolution and further gains are likely.

Figure 1: Bollinger Bands, Biotech Index. Evidence of a consolidation was also apparent with the Bollinger Bands. These volatility-based bands expand as volatility increases and contract as volatility decreases.

Graphic provided by: MetaStock.

Graphic provided by: Reuters Data.

We can return to the head-and-shoulders for an upside projection and to identify key support. The length of the pattern (neckline to head) is added to the breakout (540 - 482 = 58, 540 + 58 = 598). This gives us an upside target around 600. Broken resistance often turns into support and this is the first level to watch for signs of trouble. However, 540 seems a bit close and is not confirmed with a reaction low. As such, it would be prudent to fall back on the December 20th low at 527 (blue arrow) as key support. As long as this level holds, further strength toward 600 can be expected.

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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Biotech Index Breaks Consolidation

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