Island Reversal For Lululemon

01/23/12 09:00:38 AM

by Koos van der Merwe

We all know that when a gap forms the share price more often than not rises or falls to fill that gap. Right? Check out Lululemon.

Security: LLL-t
Position: Sell

An island reversal consists of a breakaway gap followed by an exhaustion gap caused by a price pullback to fill the original gap. Usually the time period before the pullback is one to three, even four days. Should the time period take longer than that time period, or if the price rises to fill the gap without a gap forming in that pullback, then the pattern is no longer called an island reversal. Of course, should the price be falling, then the original gap is known as an exhaustion gap, and the recovery gap is known as a breakaway gap.

FIGURE 1: CLASSIC ISLAND REVERSAL

Graphic provided by: AdvancedGET.

Figure 1 shows the share price gapping up in price, after three days gapping down forming an island reversal. We should therefore expect the stock price to fall to even lower levels. This is not confirmed by the relative strength index (RSI), which has not given a sell signal, but it is still in a bullish trend. Let us see what happened.

FIGURE 2: SHOWING THE FALL IN PRICE AFTER AN ISLAND REVERSAL

Graphic provided by: AdvancedGET.

Figure 2 shows how the price fell away on another gap, giving a JM internal band sell signal. The price then rose but did not give a buy signal by breaking above the upper band. (A JM internal band is a 15-period simple moving average offset by 2% positive and 2% negative.)

Now, knowing what an island reversal is, can we say that an island reversal is developing on the stock price of Lululemon. Let us study Figure 3.

FIGURE 3: IS AN ISLAND REVERSAL FORMING?

Graphic provided by: AdvancedGET.

Figure 3 shows how the price gapped up strongly when the company announced better financial results than the market forecast. The price moved higher for the following three days, then started to fall back to fill the gap as expected. The price could gradually drift lower to fill the gap and find support on the resistance line in the region of $57.88. This is suggested by the RSI, which has given a sell signal. Or the price could fall on a gap forming an island reversal, which means that the support at $57.88 will be weak, and the share price would fall even lower. To get an idea of how low it could fall, I have drawn in Fibonacci retracement levels.

Lululemon, a company much loved by yoga enthusiasts throughout North America and Canada, looks as though it will weaken over the coming months. However, we can continue to watch the stock to see what actually happens and make a decision at that time.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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Island Reversal For Lululemon

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