Power to the Paper

08/21/01 04:20:47 PM

by David Penn

With the S&P Paper/Forest Products sector index coming off of a three-year low, more than a few paper products companies are having excellent years.

Security: MEA
Position: N/A

One of the interesting things about technical analysis is the ability to spot a trend in a particular industry or market sector, even without knowing a single reason why that particular industry or market sector is in the kind of trend it is in. For example, the fact that the S&P Gold and Precious Metals index has been rising this year could be considered a defensive move in the face of declines in the stock market. On the other hand, the rally in Paper/Forest Products stocks seems much less explicable.

Nevertheless the rally is in effect, as a quick scan of a number of paper products companies--from International Paper to Stuffit Stone Container--attests. A number of these companies' stocks are retesting intermediate highs set earlier in the year and, should the stronger stocks successfully retest and make new highs, more gains across the sector are certainly possible.

The third test of resistance at 30.5 comes as this cup with handle formation is set up for an upside breakout.

Graphic provided by: MetaStock.

One formation that often appears when stocks are retesting highs is the cup-with-handle formation. While this formation can appear at the beginning or end of a trend, as well as in the middle as a form of continuation, when appearing at the end of an uptrend, the cup-with-handle formation can yield bullish interpretations. When in this position, the left lip of the cup often represents the new high. The top of the cup comes as prices correct from the new high. The roundedness of the correction--as opposed to a more sharp, V-shaped correction--is a sign of the moderation of the correction, and suggests that any upside move will have a more stable price pattern as a foundation.

The right lip of the cup formation represents the first attempt to test the new high. The correction that follows an unsuccessful attempt here is much shallower than the previous correction. This price action is described as "the handle," and the failure of prices to retrace deeply is another bullish sign. The resistance area formed by a horizontal line drawn from the left lip to the right lip is the area prices need to penetrate when rallying from the correction reflected in "the handle."

In the case of Mead Corporation (MEA) we note a cup with handle inside a cup-with-handle. The larger cup has a left lip at the end of January, a cup "body" that bottoms late in March, and a right lip in mid-May. The handle "body" bottoms in late June and the upside breakout looks to be develoing in mid-August. This larger cup has a formation size of about six, which anticipates a 20% breakout possibility of as high as 34 (formation size added to the value at the breakout point). The smaller cup's left lip begins where the larger cup's right lip begins. A right lip for the smaller cup exists at the top of the late July rally, with the smaller handle coming in the form of the two-week correction and rally in August. Interestingly, the formation size of the smaller cup is three, which added to the breakout point gives a compatible upside target of 33.

David Penn

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

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