Barrick Gold's 2B Top

08/27/07 08:49:43 AM

by David Penn

Look, Ma, no indicators! How resistance, new highs, and a failure to follow through helped traders trade the top in ABX.

Security: ABX
Position: N/A

I've said before that one of the most helpful things a trader can do is spend some time looking at price charts without technical indicators. I love my technical indicators as much as the next market technician. But it is often refreshing to be reminded that technical indicators are tools to assist the analysis, not to replace it.

I was listening the other day to Peter Schiff of Euro Pacific Capital make the case for gold, if not gold stocks. In noting that some gold stocks had held up relatively well, Schiff pointed to Barrick Gold (ABX) as an example of a gold stock that was making "new 52-week highs as recently as last week." Not having paid much attention to Barrick Gold, I decided to take a look.

That excursion into 52-week-high territory provided an excellent example of one of my favorite technical trading setups: the 2B. Found here as a market is making a top, the 2B is, as trader Victor Sperandeo wrote, one of the best ways to catch a change in trend — or even a profitable correction — as early in the change as possible.

FIGURE 1: BARRICK GOLD, DAILY. A month-on-month 2B top in ABX signaled a sharp correction in mid-August. The highlighted oval represents the confirming close for those taking short positions.

Graphic provided by: Prophet Financial, Inc.

Note how Barrick Gold (ABX) rallied from late June into early July in a near-vertical path en route to new 52-week highs (Figure 1). The stock pulled back sharply before vaulting higher again in late July going into August. The second advance notched an intraday new high, but by the close, the market had fallen back. This created the opportunity for a 2B top. If the market for Barrick Gold failed to continue moving higher and, instead, reversed and closed below the low of the 2B pattern (which includes the lows of both the initial and the second new high), then a 2B top would be in effect. Traders who had been long going into the 2B would have the warning they need to reduce their exposure. More aggressive traders would now have their signal to get short.

The confirmation came swiftly as the market following the second new high closed below the lows of the previous two new-highs sessions. That close was a confirming close for the shorts, who would have been able to take positions against Barrick Gold as of the end of day on that session (August 13 at 33.59).

I like to look at these trades through the lens of an option buyer since I do not trade common stock. As of the close on August 13, the September 32.50 calls were trading at about 1.00, while the September 30 calls were trading at 0.35 (although it is often not recommended, I still tend toward out-of-the-money options). The 32.50 level represented an area I believed ABX had to fall to if the 2B top was legitimate. The 30 level represented an area I believed Barrick Gold could fall to based on the distance from the top near 35 to the mid-July, intrapeak low just south of 32.

Barrick Gold fell apart almost immediately. By the morning of the third day after the confirmed short on August 13, the stock was in free fall. This day turned out to be a selling climax (note the volume), and the long lower shadow on the candlestick line on August 16 shows that the bearish momentum was evaporating as the market moved into the close.

This kind of candlestick pattern is a loud signal for traders on the short side to begin reducing exposure. Sure enough, within days Barrick Gold was moving almost vertically back up as short-side traders who had overstayed their welcome rushed to cover.

How did the options plays turn out? As of the close on August 16, the September 32.50 calls had gone from 1.00 to 3.00, with an intraday print on the 16th as high as 3.80. The September calls had gone from 0.35 to 1.60, with an intraday print on August 16 as high as 2.00.

David Penn

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

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Barrick Gold's 2B Top

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