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ANDREWS PITCH-FORK


TWM Hits Median Line, So What Next?

05/25/10 08:51:24 AM
by Alan R. Northam

The Russell 2000 Inverse ETF has now hit the median line of the Andrews pitchfork but failed to hit its initial price target. What next? Should we expect TWM to reverse back down or continue up to hit its initial price target?

Security:   TWM
Position:   N/A

In my previous article entitled "Russell 2000 Inverse ETF Now In Uptrend," I showed how this exchange traded fund (ETF) established itself in a new uptrend. I also showed how to properly draw an Andrews pitchfork and how to use this pitchfork to determine an initial price target. I also explained that once price hit the median line of the pitchfork, the price could reverse direction. By examining the price action of the Russell 2000 Inverse ETF (TWM), it can be observed that price has now reached the median line of the pitchfork and has reversed back down but did not hit the initial price target. The question now becomes: "Do we go ahead and close out the trade, or let the trade run and see if it will turn back upward and hit the expected price target?" To answer this question, we need to examine the evidence that price action has left behind.

Looking at Figure 1 we see that price made a higher low on May 13 and made a new higher high on May 21. This satisfies the Dow theory for an upward trend where the theory states that an upward trend is identified by a market making higher lows and higher highs. Therefore, TWM is currently in an established uptrend. This is bullish!

FIGURE 1: TWM, DAILY. This chart shows the Andrews pitchfork and initial price target.
Graphic provided by: MetaStock.
 
Second, we should check momentum to see if price is still accelerating upward. This will give us a sense of the strength of the uptrend. Note that price usually starts to decelerate before changing directions. To measure price momentum, we can use many different indicators, but I have chosen to use the rate of change (ROC) indicator. In Figure 1, the chart above the price chart is the ROC indicator. I have chosen a lookback period for this indicator of five days. This indicator compares the most recent price of TWM to its price five days ago. If the ROC is positive, it indicates that price is higher than it was five days ago. Of course, we could simply look at the most recent price on the price chart and compare it to its price five days ago and determine that price is higher today than it was then. However, what is not so obvious is that recently, ROC made a new higher high, indicating that the momentum of price is now stronger than it has been since the current uptrend began in early May. This is bullish!

Third, we should check volume. Increasing volume is a requirement for price to move upward as it is the force behind the move. Increasing volume is also a requirement for price to move downward in a bear market trend. Volume, however, normally decreases during market corrections in either bull or bear markets. You may have heard the phrase "Increasing volume is required for upward trending markets but markets can fall under its own weight." This means that increased volume is required for uptrend markets but not for downtrend markets. I find this to be true for uptrends and for market corrections, but I do not find it true for bear market trends. During established bear markets, everyone is selling stock, which means that volume is high and not low as the saying goes. Volume can be measured by looking at the volume histogram usually plotted below a price chart or by analyzing a number of different volume indicators. I have chosen to use the on-balance volume (OBV) indicator as shown below the price chart in Figure 1. Note that the OBV has been forming higher lows and higher highs since the beginning of the uptrend in early May. Again according to the Dow theory, this puts volume in an established uptrend. This is bullish!


The last thing we should discuss is the last trading bar. This bar has formed a classic closing price reversal pattern, whereby a new high forms with the open near the high, the close near the low, and the close below the previous day's close. We must keep in mind that one-bar reversal patterns are short-term reversal patterns and not long-term reversal patterns.

However, every long-term market reversal begins with a short-term reversal pattern. While we should not take one-day reversal patterns lightly, this latest one-day reversal pattern most likely indicates that TWM is entering a short-term correction to correct for its recent gains over the last four trading sessions.

Since market corrections normally last for a shorter period of time than the previous rally, any market correction at this point should only last for a day or two. One way we can check to make sure that any short-term selloff at this point is to watch volume. Volume should decrease on any day during an expected market correction where the price bar forms a lower high and a lower low.

In conclusion, all the evidence indicates that TWM should continue higher in the days ahead toward the initial price target of $23.27. Price is still in an established uptrend, the rate of change indicator suggests that the uptrend is the strongest it has been since the rally began, and volume, the force behind the move, is in an uptrend. However, the closing price reversal bar, the last bar on the chart, suggests that TWM may enter into a short-term market correction before heading higher to hit the initial price target. However, a move below the support line or the lower line of the pitchfork, labeled L-MLH, would indicate that TWM is moving lower and not higher and traders with open positions should act accordingly.



Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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