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TECHNICAL ANALYSIS


The Two Trendlines Of Starbucks Corp.

05/04/06 10:23:51 AM
by David Penn

Breaking down below a short-term trendline, Starbucks stock finds support above a long-term one.

Security:   SBUX
Position:   N/A

I was setting out to make an allusion to the fabulist story The Two Deaths Of Quincas Wateryell by the late Brazilian novelist Jorge Amado. In that story, two groups, Wateryell's respectable family on the one side and his just-this-side-of-hobo drinking buddies (including a prostitute girlfriend) on the other, compete not only over the memory of the dearly departed Quincas, but also over the very corpse of the man. Will he be properly buried in a church cemetery, or will his friends succeed in casting Quincas into the sea that he always claimed (at least while drinking with his "riffraff" friends) would be the "only witness to his last hour"?

FIGURE 1: STARBUCKS, DAILY. The trendline from the late January 2006 lows was broken in late April. But the longer-term trendline from the mid-September 2005 lows remains intact, likely providing a source of support as SBUX endures a 1-2-3 trend reversal test of the shorter-term trendline.
Graphic provided by: Prophet Financial, Inc.
 
Maybe it was the coffee, but something about the chart of Starbucks (SBUX) reminded me of Quincas Wateryell's dilemma (Figure 1). On the one hand, SBUX has broken down below an important trendline and had begun the first stage of what could turn out to be a significant 1-2-3 trend reversal. On the other hand, the breakdown from that trendline found Starbucks slipping to support on the back of another, potentially even more important trendline. So is Starbucks breaking down ... or bouncing?

The answer, as readers of Jorge Amado's magical realist novel discovered of the "real" Quincas Wateryell, was both. In the same way that traders and investors often switch time frames in an effort to discover what is going on "in between" the bars or, alternately, what the "bigger picture" is, so can traders switch from short-term to intermediate-term trends in an effort to find potential support and resistance areas.


For example, SBUX has clearly broken down below the trendline that extends from the late January 2006 lows. The big question is whether this break represents a minor correction or a reversal and the beginning of a new bearish trend. One way of determining this is by way of the 1-2-3 trend reversal, about which I have written frequently. And one way of determining where the correction is in the 1-2-3 trend reversal methodology is to figure out whether SBUX has completed stage 1--the initial breakdown below the trendline and the establishment of a correction low.

FIGURE 2: STARBUCKS, DAILY. Breaking down below the support of a short-term trendline, SBUX finds itself bouncing off the support provided by a longer-term trendline.
Graphic provided by: Prophet Financial, Inc.
 
Looking at Figure 2, we can see there is potential support in the $35-36 area. This represents the March 2006 lows. However, when we pull our focus back to include the longer trendline from the mid-September 2005 lows, we see that the trendline provides potential support at a higher level, closer to $37. The shape of the candlesticks as SBUX moves toward this level might also be telling. After gapping down on April 27, the candlesticks in subsequent days tended to feature long lower tails or shadows, suggesting an absence of willing sellers at that level.

On the other hand, it is also worth noting the way that volume increases as prices move toward both trendlines in late April going into May. As I wrote in an article for Working Money ("Trading With Trendlines," August 29, 2005), if volume increases as a market moves toward a trendline, it tends to suggest that the trendline is in danger of being violated. This has clearly already happened with the shorter-term trendline from the March low. The question is whether this volume action is as significant for the longer-term trendline from the September lows.



David Penn

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

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