Google's 1-2-3 Course Correction

02/24/06 01:30:53 PM

by David Penn

Starting with a wide-ranging, high-volume down day, the year-to-date correction in Google was an orderly 1-2-3 event.

Security: GOOG
Position: N/A

Whether or not the intraday high of 475.11 on January 11 will be remembered as the apogee of the Great Google Stock Story, the correction that began shortly afterward represents the biggest challenge to the constitution of Google (GOOG) bulls since the stock began trading in August 2004. Whereas previous Google corrections have been sideways affairs (most recently the June to October 2005 sideways consolidation) (Figure 1), the current correction in Google has taken a decidedly downward path.

FIGURE 1: GOOGLE, DAILY. Two previous corrections in GOOG saw the stock move largely sideways for months.

Graphic provided by: Prophet Financial, Inc.

What is interesting about the 2006 correction in Google is that it very much follows the pattern of the 1-2-3 trend reversal. This method of tracking potential reversals in trending markets was popularized by Victor Sperandeo (author of Trader Vic: Methods Of A Wall Street Master) and is always a helpful tool for investors, traders, and speculators trying to determine when the trend has in fact come to an end and begun to bend.

How does the 1-2-3 trend reversal work? Each number represents a different step in the reversal process — a process that is surprisingly common among markets that are topping (or bottoming) and beginning to move in the opposite direction for a period of time. The "1" stands for an initial trendline break. The lows of this break (we'll assume the case of an uptrend in its late stages) will set a level of support below which the trader can presume that the trend has reversed. The second step ("2") refers to the effort by the market to reassert the previous trend in the wake of the trendline break from step 1. The highs of this move (again, given an uptrend) will establish a level beyond which a trader can act as if that the previous trend has been restored.

FIGURE 2: GOOGLE, DAILY. A trendline break, a failed bounce, and follow-through to the downside brought about a 1-2-3 trend reversal in the first several weeks of 2006 for Google.

Graphic provided by: Prophet Financial, Inc.

Those 1-2-3 steps are highlighted in Figure 2. The initial trendline break arrived on overwhelming volume, on a wide-ranging day that saw two previous lows taken out to the downside (the lows of December 7 and December 30). The effort to resume the uptrend is also perfectly cast. The market opened higher on January 25, even breaking back above the October–January trendline. Though not drawn, this is comparable to a market moving back inside a trend channel and, potentially, being able to draw support from that lower boundary — in this case, merely that October–January trendline.

However, the highs of the session on January 25 could not be sustained and the market ended up closing significantly lower — and back below the trendline. Google meandered for about four days before gapping down and taking out the low established by the initial trendline break. Step 3, confirming the reversal, had occurred and lower prices for Google followed immediately afterward.

David Penn

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

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