CISCO At Support

01/22/10 11:47:55 AM

by Chaitali Mohile

After a bullish breakout, Cisco turned sideways with the robust support of the 200-day moving average. Will the stock break down or will it sustain near support?

Security: CSCO
Position: N/A

A positive divergence of the moving average convergence/divergence (MACD) (12,26,9) and the full stochastic (14,3,3) was a robust trend reversal indication for Cisco Systems (CSCO). The price made lower lows in 2008-09 in Figure 1, but the MACD (12,26,9) formed a higher bottom and showed a bullish crossover as well. Thus, a fresh bullish rally was born after a long and robust corrective phase. The average directional movement index (ADX)(14) descended from an overheated region, suggesting a trend reversal possibility. Due to these highly bearish conditions, the downtrend reversed gradually. Hence, the positive divergence and an overheated downtrend initiated the new rally from the lower levels.

A bullish engulfing candlestick pattern at the bottom reconfirmed the entire bullish reversal picture in Figure 1. This article helps us to understand the strength of candlesticks and the effects of their highs and lows on rallies. The small bearish candlestick in the black rectangle is an inverted hammer -- a bullish reversal candlestick pattern. The second large bullish candle hugged the inverted hammer, forming the bullish engulfing pattern. Increased volume showed confidence in the candlestick pattern and supported the bullish journey of all the three indicators. Thus, CSCO rose higher and higher, recovering its losses.

FIGURE 1: CSCO, WEEKLY. The stock turned sideways after converting the 200-day MA resistance to support.

Graphic provided by: StockCharts.com.

Gradually, the 50-day moving average (MA) resistance was converted to support. The stock struggled to establish strong support at the 50-day MA. In the yellow block, we can see that CSCO ranged within the high and the low of the first bullish candle. The high made by the candle restricted the upward price action and the low offered robust support.

Meanwhile, the ADX (14) moved in favor of bulls and the MACD (12,26,9) surged into positive territory. The bullish indicators added strength in the price rally; as a result, CSCO violated the short-term previous high resistance of the candlestick. On these bullish notes, the stock hit the 200-day MA resistance. But the stochastic oscillator turned volatile in an overbought zone between 50 and 70 levels. The MACD and trigger line converged, indicating reducing bullish momentum. The momentum indicator in Figure 1 showed a bearish crossover. This shows significant volatility in the stock. Thus, the 200-day MA breakout turned sideways with the newly formed MA support.

CSCO has been consolidating for almost four months. Although the ADX (14) is indicating the developing uptrend, the MACD (12,26,9) and the stochastic is still volatile in the bullish areas. The uptrend is developing with equal buying and selling pressure. The positive directional index (+DI) and negative directional index (-DI) are moving parallel, signifying consolidation during an upward rally. The entire scenario, therefore, highlights consolidation for CSCO. However, the stock might correct if it fails to sustain the 200-day MA support.

FIGURE 2: CSCO, DAILY. For the stock, $23 and $22.50 are the near-term support.

Graphic provided by: StockCharts.com.

On the daily frame in Figure 2, CSCO has rested on a very important support level. The support area is created by an upper range of the previous consolidation, the 50-day MA support, and the earlier bullish candlestick low. The long upper shadow of October 19 formed a strong resistance line for the stock, restricting the upward movements. Thus, the rally was suppressed by the resistance. The 50-day MA support was challenged frequently. Although CSCO bounced from this support, it could not reach the prior high pivot, indicating lack of strength. The MACD (12,26,9) moved with the support of the zero line in Figure 2. The full stochastic (14,3,3) formed lower highs, indicating weakness. Therefore, the upper-range breakout at $23.98 retraced after hitting the candlestick resistance.

The stochastic declined from an overbought area; see the marked circle. This shows that the stock was turning weaker. The bullish engulfing pattern confirmed the weakness and dragged the price toward the immediate support at $23.98. Currently, both indicators are likely to turn bearish for a short time span. This could pull the price further down towards the next support of $23.

Thus, volatility is likely to increase in CSCO and would breach the supports at $23. The 200-day MA support on the weekly time frame will hold maximum importance. But the long-term uptrend is likely to sustain.

Chaitali Mohile

Active trader in the Indian stock markets since 2003 and a full-time writer. Trading is largely based upon technical analysis.

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CISCO At Support

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