Starbucks' Island Reversal

02/14/02 12:06:50 PM

by David Penn

Up 59% from the September lows, Starbucks looks filled to the brim.

Security: SBUX
Position: N/A

Gaps moving to the upside can be excellent opportunities for buyers. Often, a continuation gap--in which, for example, the open is significantly higher than the previous close in an uptrend--is a signal of new energy (in the form of more aggressive buyers) entering the market. When this occurs relatively early in a new trend, such gaps can be tradable and profitable. However, when these gaps come later, in more mature trends that have already appreciated by 30%, 40% or 50%, traders and investors need to be wary that "new energy" is not really the "late energy" of those buyers who have hesitated until the last minute to join the rally. These gaps are more often "exhaustion" gaps that tend to anticipate the end of the trend as opposed to the trend's continuing.

The Starbucks (SBUX) gap in January 2002 started off as what probably appeared to be a continuation gap at the time. Even though SBUX had climbed 44% off its September low, SBUX had experienced both a moderate correction in November (prices sagged from just under 20 to just over 17 before returning to 20 in December) and a solid month-long consolidation in December. In fact, it was the consolidation in December that led to the upside breakout in January. SBUX went from 19.5 to just over 22 in two days early in January and went on to register a 52-week high just shy of 24 at the end of the month.

Starbucks' near 60% advance may come to an end in this island top.

Graphic provided by: MetaStock.

Since that time, SBUX has retraced back to around 21.5. This area represents a source of major support for SBUX at this time. SBUX has not dipped below about 21.3 since gapping up at the beginning of the year. This price action resembles the first half of an island reversal top, in which prices gap up, then consolidate for a period of time before collapsing (an island reversal bottom is the same, only in reverse). The current island top in Starbucks (if it is a reversal has yet to be decided) is about 28 days long. However, island reversals can last for a few days or a few months, so the duration of the SBUX island does not tell as much as preferred.

But the uptrend line, coming off the September lows, might help in developing a sense of when the island is more likely to make a major move. That trendline intersects the island's support area of 21.3 by the end of February or the beginning of March. This suggests that, by that time, the island will have likely tipped its hand as to whether any breakout will eventually be bullish or bearish. Given the size of the island (approximately 2.5), a downside breakdown (or successful island reversal top) would take SBUX to about 19, the thick of the December consolidation. Any movement to the upside from current levels (about 21.5) should still be monitored, however, with the top of the formation being the area of resistance to any advance.

It is worth pointing out a few other bearish characteristics of SBUX at the present time. The first is the possbility that the island top in SBUX will turn into a head and shoulders top. In such an event, the left shoulder and head are already formed, and a rally back to 23 before a final test of the intermediate "formation" bottom at 21.3 are all that would be necessary to complete the formation. The downside target would even remain the same. Additionally, the low 20s have been difficult areas for SBUX to traverse toward higher ground. The May/June rally in 2001 topped out at 23. A January 2001 rally topped out at 25.5. An October rally in 2000 topped out at 25. A summer 2000 rally topped out at 22 ...

David Penn

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

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Starbucks' Island Reversal

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