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CHART ANALYSIS


Saucer Bottoms And Trend Reversals

07/29/09 09:18:43 AM
by Donald W. Pendergast, Jr.

Traders can learn to profit from major trend reversals by employing visual analysis techniques along with a few simple technical tools.

Security:   TEN
Position:   N/A

Tenneco's wild ride south took the stock from $37.73 in August 2007 all the way down to $0.67 in March 2009. By most conventional measures, most investors and traders probably wouldn't have considered touching this beaten-down stock with the proverbial 10-foot pole. Yet, look at the astounding reversal that occurred after the final lows were made; the stock has recovered a third of its former high in less than five months. Let's look at some of the tell-tale clues that were hinting that Tenneco (TEN) might have been a fairly low-risk long trade entry, especially as the broad markets reversed higher in sympathy.

FIGURE 1: TEN, WEEKLY. Saucer bottoms and the bullish breakout moves occurring in their wake can frequently lead to profitable trend-following moves.
Graphic provided by: MetaStock.
 
Figure 1 is TEN's weekly chart, detailing the technical journey of the automotive industry group stock over the past 10 months or so. Obviously, the stock wasn't a favorite of institutional money managers once it plunged into the "sub-$5 a share" bin, but the pronounced bullish price-momentum divergence that showed up when the relative strength index (RSI) (14) was compared to the weekly action in the stock itself must have caught the attention of some deep-pocketed bottom-fishers, who put the stock on their radar screens. This was about the same time that the broad US markets bottomed and reversed sharply higher, also pulling up TEN in its wake.

As the stock caught a bid, it proceeded to break above the downtrend line that formed the top of the descending wedge pattern, causing even more traders to take note. A spike high printed in mid-March, followed by a six-week long consolidation platform pattern, the kind typically seen after a stock has completed a major reversal.

Now the setup was in place; traders looked for the breakout above this weekly platform, and they got what they wanted during the week ended May 1, 2009. At this point, there was no question that this stock was on its way higher, but as usual no one could have accurately called the incredible multimonth trend move that has emerged from such a humble price level.

This first breakout (see the short red dashed horizontal lines) would have been an ideal place to put on half of a position, trailing the anticipated move higher with a 2 * ATR 10 volatility trailing stop (green dots on chart). Also worthy of note is that the weekly RSI(14) never dropped below 50 level as the platform developed, a major tipoff that a bullish breakout of the pattern would likely have some staying power. (The reason for this, of course, is that an RSI(14) reading above 50 implies that a strong trend may be developing, all else being equal.)

The following week (ending 5/8/09), the stock followed through with a 95% gain, again offering trend-followers a second entry point (see the red dashed lines again) to add the second half of their positions. You can bet that the mutual funds were really getting interested, what with the stock roaring higher out of the cellar and thousands of momentum players jumping on board the powerful move. Those who entered somewhere between $3 and $4 and who also elected to use the trailing volatility stop (green dots) were already near breakeven by this time, allowing them the luxury of riding the trade out in hopes of more substantial gains -- and with limited risk.

Price consolidated for a few weeks after that massive range bar, forming a well-defined pennant, one that also could be categorized as a continuation pattern. A bullish continuation pattern implies that an upward breakout from the pattern will result in a substantial continuation of the initial move up to the point of pattern formation.

Well, all the lucky charms were working on this one, because that's exactly what happened -- as TEN broke from the pennant (also known as a triangle), it proceeded to gain 95% in less than two months, which is precisely where this high relative strength stock is right now.

There is another technical clue on the chart; note the purple curved line at the bottom of the chart. It basically traces out what some technicians refer to as a saucer bottom formation. Identifying chart patterns can be difficult at times, and no two are exactly alike, but this weekly price action in TEN between November 2008 and May 2009 certainly does seem to meet the definition of a saucer or rounded bottom pattern. You would still have needed to rely on the other technical tools discussed in order to time an entry, but the saucer pattern would have been a wonderful secondary confirmation, adding an extra dose of confidence to those who actually went long on TEN between May and June 2009.

Finally, trend-followers and momentum traders would also do well to examine the relative strength rankings of the stocks they intend to trade prior to actual entry. In this case, TEN had excellent relative strength (based on a 13-week rate of change) versus the Standard & Poor's 500 during May and June 2009, the period in which all three hypothetical long entries would have been made.

Taken as a whole, using all of the technical tools and evaluation techniques described here would have allowed an industrious trader to make a nice profit on this particular stock. Now that you know what to look for the next time the broad market makes a major low, see if you can apply some of these techniques to the stocks and exchange traded funds (ETFs) that you normally trade.



Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address: lineartradingsys@gmail.com

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