A Pan American Silver Corp. 2B Bottom

10/31/06 09:12:10 AM

by David Penn

A hammer candlestick puts the finishing touches on a picture-perfect 2B bottom in early October.

Security: PAAS
Position: N/A

Seasonality suggests good things for gold and silver stocks from mid-summer to early autumn. This is according to the research of Yale Hirsch and the team at the Stock Traders' Almanac. If the stock of Pan American Silver Corp. (PAAS) is any indication, then Team Hirsch again has provided a great service to speculators and investors. Since Hirsch specifically says the sweet spot for gold and silver is from "early" July to "early" September, let's take a look at PAAS' performance from the first trading day of July to the first trading day of September.

FIGURE 1: PAN AMERICAN SILVER CORP., DAILY. Failure to follow through to the downside after the intraday penetration of the 18 level was one of the primary clues that the correction in PAAS had run its course.

Graphic provided by: Prophet Financial, Inc.

On the first trading day of July, PAAS closed at 18.45. On the first trading day of September, PAAS closed at 23.03. That's a gain of 4.58 points, or nearly 25% over the course of two months.

Again, if we are to use PAAS as our proxy, then it is apparent why Hirsch qualifies the trade with "early." The stock continued to advance for a few days into September before collapsing, falling from a early September high north of 23 to a midmonth low near 18. As PAAS stumbled into October, it was again testing the 18 level for support.

However, Figure 1 helped provide a clue whether PAAS would be heading significantly lower, a clue in the form of a 2B bottom between the mid-September lows and the early October lows. When PAAS made a lower low in early October, pressing below the 18 level on an intraday basis yet failed to follow through to the downside in subsequent days, traders had been given a strong indication that the decline in PAAS had come to an end. To play the 2B, traders used the high of the initial, mid-September low -- approximately 18.90 -- as their entry point and the low of the second, early October low -- approximately 17.50 -- as their stop.

The efficacy of the 2B bottom was enhanced by the presence of a hammer candlestick on the second, early October low. This candlestick charting pattern is especially powerful when it appears after a trend, as well as when it appears on significant, above-average volume, which was the case here. The hammer candlestick -- so-called both because it visually resembles a hammer and because its appearance is said to "hammer in" a bottom -- features a small "real body" and a long tail or shadow (or wick, for that matter) beneath it, indicating an inability on the part of sellers to close the market at or near the lows of the session.

FIGURE 2: PAN AMERICAN SILVER CORP., DAILY. Positive divergences in both the MACD histogram and the stochastic provide a high degree of confirmation that both the 2B bottom and the hammer candlestick pattern are accurately forecasting a tradable low in early October.

Graphic provided by: Prophet Financial, Inc.

But if a 2B bottom with a hammer candlestick on above-average volume is good, then how much better is a 2B bottom with a hammer candlestick on above-average volume that also comes equipped with positive divergences in both the MACD histogram and the stochastic? The answer: Much, much better. In truth, it is often surprising how frequently 2B bottoms develop alongside other clues indicating a short-term low, such as bullish reversal candlestick patterns and positive divergences in key oscillators. This underscores the idea of using complimentary technical tools as often as possible to help determine whether instances that appear to yield only marginal trading setups might in fact possess truly great opportunity. See Figure 2.

As for the upside, a simple swing rule projection based on the two troughs (second half of September and the first half of October) and the high points between them suggested an upside to about the 22 level (based on a formation size of two points). It is interesting to note that this level is precisely where PAAS began to run into a bit of resistance late in October.

David Penn

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

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