The Taking of Time Warner TLC

08/09/01 10:43:59 AM

by David Penn

A descending triangle follows an intermediate head and shoulders top as the bears drag Time Warner Telecom down.

Security: TWTC
Position: N/A

One of the most important lessons to be learned from pattern recognition, it seems to me, is that patterns are often most profitable when they come in bunches. A flag or pennant in the middle of a breakout from a double bottom can be a place for bulls to take profits. But it can also be an opportunity for savvy traders to reload, speculating that the flag or pennant may be just the continuation formation that helps a tradable reach its price objective. Even better, a continuation formation at the end of a solid breakout can be the earliest tip-off that further moves in the same direction might be just ahead.

An example of this phenomenon may be happening to shares of Time Warner Telecom (TWTC). TWTC was declining precipitously into the mid-spring, reaching a low in the high 20s at the beginning of April. Like many stocks, TWTC enjoyed a major boost during the April rally, eventually reaching an intermediate peak of about 55. It was a third attempt to advance beyond this area that revealed the intermediate head and shoulders top in TWTC, extending from mid-April to the downside breakout at the beginning of June.

Combinations of chart patterns can serve as valuable confirmations during downtrends.

Graphic provided by: MetaStock.

The downside price objective for this intermediate head and shoulders top was about 25. This was derived by subtracting the formation height from the value at the point of the downside breakout. This objective was reached in a little over two weeks, a 37.5% gain for those bears who correctly played the breakout. What is interesting here is how TWTC rallied from the new year-to-date low at 25. The rally stalled out just short of 35 at the beginning of July, as prices corrected back down to the 25 level. A second rally at the end of July also failed--barely climbing above 30 and again returning to 25.

This pair of failed rallies, with the second rally being smaller than the first, help set up the descending triangle. These rallies, in fact, peak along a downwardly sloping resistance line that extends from the two-day rally peak early in June to the final rally attempt in July. The horizontal support line that completes the descending triangle can be found along the 25 level. This support level was crossed on the downside in mid-August on exceptional volume, in fact the biggest volume day since early May. Given that prices already had moved approximately two-thirds of the way through the triangle, this downside breakout on big volume is very significant.

How significant? Using the standard measurement rule for descending triangles, it is not impossible to see a drop of as much as twelve points in Time Warner Telecom. Of course, this is a severe drop (nearly 50%) in a stock that was trading at 70 as recently as early March, and traders don't need to attempt to ride the entirety of any breakout in order to find a good trade. Additionally, such a major decline could set the stage for a final bottoming in TWTC, as value players consider shares that are trading at as much as an 85% discount to their March price.

Incidentally, I noted that Morgan Stanley has iterated its STRONG BUY rating for TWTC, suggesting that the market has "overreacted" to news that TWTC revenues in 2002 will be subpar. I have no idea whether or not the market is overreacting. But given the fact that three days of outstanding trading activity this spring--in mid-March, early May and early August--have all taken TWTC down, it seems as if TWTC is likely to become an even greater bargain for those interested in buying, strongly or otherwise.

David Penn

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

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The Taking of Time Warner TLC

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