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Microsoft's Ugly Head and Shoulders Bottom

05/30/01 01:52:43 PM
by David Penn

You don't have to call it a head and shoulders bottom. But this bottoming movement in Microsoft may boost the Software King to 80 or more.

Security:   MSFT
Position:   N/A

One of the things many of the people in the Linux operating system community and other computer geeks used to say bitterly about Microsoft's operating system was that Windows was a big, ugly mess. Not a painting with layers of previous efforts, they would say, but a set of furniture that had been glued, taped, nailed and retaped into working well ... that was allegedly the more accurate representation of the Windows operating system as far as some of these anti-Microsoft folks were concerned. Now whether the Linux folks were right or not is a matter of debate. But I will apply their metaphor of the Windows operating system to the big, ugly head and shoulders bottom MSFT appears to have developed, beginning in the summer of 2000.

What keeps this from being a more articulate head and shoulders bottom is the consolidation that occurred in August of 2000. The left shoulder can be considered to span from the consolidation peak in June 2000 until the consolidation in late October. The August 2000 consolidation is really more of an aesthetic problem. Prices could have rallied to the neckline in the high 70s instead of stalling out in the low 70s. Then the left shoulder would simply begin in August instead of June. Once this cosmetic issue is cleared up, however, the rest of the pattern conforms well to the head and shoulders bottom. The head of the pattern spans from the early November consolidation to the trough's low in mid-December and back to the top of the January 2001 rally. The right shoulder was an abbreviated affair: from the peak of the January rally to the peak of the April rally, where prices broke a downtrend of over 10 months.

Figure 1: Microsoft's Head and Shoulders Bottom.
Graphic provided by: MetaStock.
It gets better. Breaking out at 60, MSFT headed to 68 by late April, where the stock went into a 4-point consolidation range extending into the last week of May. This consolidation in the midst of a breakout gives the breakout much more opportunity to reach its price objective. Often breakouts that have no consolidation before reaching their price objective have a difficult time sustaining the upward move compared to breakouts that are "interrupted" by consolidations. They are buying (and selling, for that matter) stations for those who believe the stock is going up.

Microsoft could go up. If the head and shoulders bottom breakout continues, MSFT could reach as high as 86. The formation size of 26--measured from the neckline to the top of the head--added to the value at the breakout point (60) gives us the 86 upside price objective. The current consolidation area, a little less than midway toward the upside objective, is an area of historic resistance; rallies in August and October 2000 failed at these levels. There will be some resistance in the high 70s and low 80s should MSFT make a move toward new highs (and 86 would represent a 52-week high in MSFT), but such resistance is what new highs are made for.

Know that MSFT is no stealth stock and that breakouts in MSFT will need to be accompanied by impact-sized volume in order to resist the inevitable run on the stock by those looking to sell. As such, vigilance against false breakouts is key. Still, the breakout from the head and shoulders bottom was clear, and the consolidation between the high 60s and the low 70s may be the stock's best attempt at a pullback. Also supporting a bottom in MSFT is the new uptrend projecting from the December low.

Those anticipating a summer rally in stocks may search far and wide for a leader. They may need not look much farther than Microsoft.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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