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Hewlett-Packard's Descending Triangle

08/06/01 03:47:34 PM
by David Penn

May bulls become August bears as HWP looks to break out on the downside from this continuation formation.

Security:   HWP
Position:   N/A

What began as a 20+% gap up on big volume in May could end as a 20+% drop in August if the descending triangle in Hewlett-Packard proves successful. The breakdown at the end of July, on the heels of still yet another disappointing revenues/earnings warning from the company (the sixth in 2001) was exceptionally bearish--even for a sector that has been battered for a year. This is evident not only in the two-day gap down from an open at 26.5 to a close of 23.5 (11%), but also in the volume traded, which was more than twice the 30-day moving average of volume.

The previous up move in May was significant in two ways. On the one hand, anyone prescient enough to have caught the oversold situation in HWP could have made a quick 20% or more in about two days. On the other hand, the up move did not successfully test the April high of about 34 (the May advance peaked at about 31). This failure meant that the downtrend in HWP was very much still intact and, true to form, HWP did resume its decline. As the chart shows, the nature of the decline involved a repeated, if weak, test of a bottom at about 25.5 or so, while resistance was gradually moving lower, marked by both the downtrend line from the May peak and the 39-day moving average (in red). This combination is characteristic of the descending triangle pattern which, as a continuation pattern, anticipates further declines for the tradable in question.

Breakout or bear trap? A rare pullback in a descending triangle adds to the risk of a failed breakout in Hewlett-Packard.
Graphic provided by: TC2000.com.
 
The reason behind this may be clear, but is worth restating. The declining resistance line reflects fewer and fewer buyers; fewer buyers means less demand and prices have a difficult time rising in such a market. Thus, the declining resistance line is helpful indicating graphically how ample supply is, driving prices back down (in the form of the common gap downs at the beginning of July and the high number of sell days in the second half of July) each time demands builds and prices start to rise (particularly at the end of June and at mid-July).

The support line at 25 is, again, not vigorously tested. The decline in June makes an intraday test of support, and another intraday test comes during a decline in the first half of July. And there is the intraday decline to 25 in April and May at the beginning of the formation. While not perfect, the 25 area did appear to represent some short-to-intermediate support for HWP. When I initially looked at HWP, it was before the August 1st rally back into the formation. Trading today (8/6) took prices back to test the support at 25.

My first thought on HWP was that a pullback that took prices back into the formation would complicate any downside breakout. While I still have some reservations about HWP, trading in recent days has resumed the bearish campaign. While false breakouts from descending triangles are generally less common than with other formations, the swiftness of the correction in this case may be enough to restore courage to those looking to sell HWP. In any event, the 25 level remains vital for the progress, up or down, of HWP. A successful downside breakout could take HWP as low as 19 (a 24% drop). This assumes the measurement rule that subtracts the formation height from the value at the breakdown point.



David Penn

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

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