A Double Top In Telecom?

12/19/06 10:16:00 AM

by Arthur Hill

The North American Telecom Index is challenging its prior high, but a big negative divergence in the moving average convergence/divergence means traders should also be on guard for a double top.

Security: $XTC
Position: Hold

The double top is a bearish reversal pattern with two roughly equal tops and an intermittent low in between. It takes a move below the intermittent low to confirm the pattern and project further weakness. The North American Telecom Index (XTC) formed a reaction high around 935 in late October and is again challenging this high. In between the two highs, XTC forged a reaction low around 895 and it would take a close below this level to confirm a double top. After confirmation, the length of the pattern would be subtracted from the breakout point and the downside target would be to around 855 (935 - 895 = 40, 895 - 40 = 855). The 200-day moving average is currently around 845 and there is support from broken resistance at 837. Taken together, I would expect support somewhere between 835 and 855. See Figure 1.

FIGURE 1: XTC, DAILY. XTC formed a reaction high around 935 in late October and is again challenging this high.

Graphic provided by: TC2000.com.

Graphic provided by: Telechart 2007.

I am entertaining thoughts of a double top because the moving average convergence/divergence (MACD) has a large negative divergence working over the last few months. The MACD surged from late May to early August and then traded at a relatively high level until the end of October. This shows sustained strength. This key momentum indicator then declined to the zero line in late November, and the December bounce remains well below the prior highs. The lower high shows less upside momentum on the current advance and the rally could fail.

FIGURE 2: XTC, HOURLY. A break below 895 would confirm the double top and call for a medium-term trend change.

Graphic provided by: TC2000.com.

Graphic provided by: Telechart 2007.

For early signs of weakness, I am going to home in on shorter time frame and use the 60-minute chart, which covers the December advance (Figure 2). The MACD moved into positive territory in early December and stayed positive the entire time. I am looking for two things to identify a trend reversal. First, MACD should move into negative territory and this would turn momentum bearish. Second, XTC should break the early December trendline and its mid-December low (923.6). This would reverse the short-term uptrend and call for a support test around 895. A break below 895 would confirm the double top and call for a medium-term trend change.

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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