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TECHNICAL ANALYSIS


Digene's Cup With Handle

06/29/01 03:52:10 PM
by David Penn

A correction from Digene's April rally looks to have helped complete a bullish cup with handle in DIGE.

Security:   DIGE
Position:   N/A

A co-worker recently teased me about referring to the "swoon and soar" of the cup with handle formation (see "Base-Building with Lowes" elsewhere on Traders.com). Purple prose notwithstanding, take a look at the heart-in-throat plunge in Digene and the stock's equally hair-raising rally this year. Shares of Digene fell from 40 in late January to just above 10 by mid-March. Rallying from the March lows, Digene more than tripled by mid-May to reach 33.5. If that ain't swooning and soaring, then I don't know what is!

From the rally top in mid-May, Digene shares corrected about 25% to 25, before rallying again to about 33.5. On the back of strong buying volume, as evidenced by the sudden upward pitch of the on-balance volume indicator, Digene moved rapidly past resistance at 33.5 to close just shy of 40 in late June.

It is this second movement that is most compelling insofar as it suggests that Digene has developed a cup with handle formation, the bullish chart formation popularized by William O'Neil of Investor's Business Daily fame. The current cup with handle in Digene is not exactly one that O'Neil would endorse wholeheartedly: the 60% decline from the cup top (see graphic) far exceeds the 15% to 30% that he recommends (though Thomas Bulkowski in his book "Encyclopedia of Chart Patterns" offers that such cup troughs can run as deep as 50%). But I am drawn to the pattern's otherwise cup with handle-like qualities, in particular the formation of the handle, which is at least proportionate in size to the somewhat oversized cup.

Figure 1: A deeper than usual cup with handle formation, Digene is likely to pullback before reaching its price objective of 44.
Graphic provided by: MetaStock.
 
The cup with handle formation looks very much like it sounds. Prices decline in a more or less rounded fashion, then rally in a similarly rounded way to reach a resistance point at or near where the decline began. Prices then correct down about 15% before rallying again and, when the formation works, breaking out on the upside. Here, the handle phase corrects somewhat more than 15% (closer to 26%) which is allowable when the cup is larger than usual.

One of the problems with a cup with handle formation as deep as the one in Digene is that any sustained advance begins to look a little V-shaped (Digene has essentially quadrupled since the middle of March). As such, it is wise to be on the look out for signs of exhaustion or fatigue in the advance. An adjusted measurement rule for cup with handle formations actually helps keep upside ambitions in check. The adjusted rule calls for half the formation height to be added to the top of the formation, which in this case produces an upside price objective of about $44.

Another note-- Bulkowski suggests that cup with handle upside breakouts often suffer pullbacks. As such, Bulkowski recommends not even buying the breakout and instead, simply waiting for the pullback, which should take prices back toward the original breakout area. With Digene's upside breakout looking ready to rest (the last candlestick shown, from June 28, has a long top shadow, suggesting an inability to force a close nearer to the high of the day), could this pullback presage the rally Digene longs are looking for?



David Penn

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

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Date: 06/30/01Rank: 5Comment: 
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