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HEAD & SHOULDERS


Shipper Slips From Head And Shoulders Top

02/07/05 09:38:40 AM
by David Penn

Many stocks in this group bottomed in December 2004 and spent January 2005 in rally mode. In this stock, a failed topping pattern helped anticipate the advance.

Security:   GMR
Position:   N/A

I found the shipping stocks the old-fashioned way. I looked up a list of the top-performing industry groups since the year began. And what to my wondering eyes should appear very near the top of that list but the Dow Jones US Marine Transportation Index? Sure, there were other January high-fliers (including the Dow Jones US Tires Index), but the more than a few of the radio stock jockeys I listen to have mentioned shipping stocks, so I thought I'd give them a look.

In general, many of these stocks did correct over the course of December, a time during which most stocks were rallying. There were exceptions, of course, such as Seacor Holdings (CKH), but they tended to prove the rule. And as the rest of the market was topping as January began, many of the shipping stocks lifted anchor and began moving forward in their own right.


Figure 1: General Maritime (GMR). A positive stochastic divergence as December became January was a sign that GMR was, on balance, more likely to move higher in the near term as opposed to lower.
Graphic provided by: Prophet Financial, Inc.
 
What drew me to the chart of General Maritime (GMR) (Figure 1), however, was somewhat less its role as an example of shipping stocks and more its role as an example of the perils of anticipating chart patterns. From the perspective of late December or early January, GMR looks to be setting up a head and shoulders top. General Maritime put in a low near 18 back in the late spring of 2004 and, by the time the stock put in its high for the year, it had advanced by more than 175%.

So GMR was a market that was due for a correction, if not a top. And moving into January--particularly with the broader market so weak--it seemed as if General Maritime might be about to provide that correction or top in the form of a head and shoulders top. Sure, the formation was not complete in early January. But prices had fallen below their 10- and 50-day exponential moving averages (EMA) and the general market was so weak, so ...

I keep a quote from the American War of Independence on the wall of my cubicle. It's the famous "Don't one of you fire until you see the color of their eyes!" order by American officer William Prescott in advance of the Battle of Bunker Hill (apparently "color of their eyes" was the actual phrase used; "whites of their eyes" was the creation of historians). As I am someone who so often looks for plays among reversal situations, Prescott's invocation has all the weight of a commandment as far as I'm concerned.

And that commandment would have served well for anyone looking to short General Maritime on the basis of its "all-but-completed" head and shoulders top. It is true that the devil is in the details, and here it is the "all-but" part of the details that would prove to be the bears' undoing. Just as GMR appeared ready to roll over, it gapped up in mid-January, consolidated over the next few days as the end of the month drew near, then exploded upward again, shattering any notion of a head and shoulders top-derived breakdown.


The patient trader determined to wait for an actual break below the neckline of the prospective H&S top, a neckline at about 33, would have remained unmolested by General Maritime's surge to the upside. The aggressive trader might even have noticed the positive stochastic divergence that developed as December ended and January began, and realized that--while divergences are no guarantee--the likelihood of a quick move to the downside was relatively slight. The only loser was the overexcited trader who started selling General Maritime in early January near 36 and 37, rather than wait for the confirmation of a breakdown below neckline support.


Figure 2: DJIA. What appeared to be setting up as a head and shoulders top in the Dow Industrials increasingly looks less so, as the rally from the end
of January expands in February.

I bring up this example of General Maritime in large part because of the prospective head and shoulders top developing in the Dow Jones industrials (Figure 2) and the Standard & Poor's 500. These alleged tops have yet to be completed, and those who are wedded to the head and shoulders top thesis are likely to see in Friday's rally (on February 4) the first upward side of the final, right-side shoulder of the pattern. This may bear itself out; I've argued that the market was likely to test the 1140 level before moving on to new highs. But those mesmerized by the head and shoulders top in the Dow Jones industrials may want to consider what the General Maritime bears might have seen--or thought they saw--as the right shoulder of their head and shoulders top turned into the first stage of a reversal--back to the upside.



David Penn

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

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