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GAPS


Mind The Merck Gap

04/12/06 08:14:10 AM
by Arthur Hill

Merck had a great run, but a gap down on big volume signals a shift in opinion.

Security:   MRK
Position:   Sell

Merck (MRK) was meeting resistance just below 37 and losing upside momentum prior to the gap (Figure 1). Those two go hand in hand because momentum slows as a tradable instrument meets resistance and stops advancing. The moving average convergence/divergence (MACD) peaked in mid-January, but the stock itself did not peak until late February with a bearish engulfing pattern (red oval). After a shallow pullback to the 50-day simple moving average (SMA) in early March, MRK moved toward resistance and failed to break out. As a result of flat trading and an inability to break through resistance, MACD continued toward the zero line, which reflected waning upside momentum.

FIGURE 1: MERCK. Is upside momentum waning?
Graphic provided by: MetaStock.
 
Looking back at December 2005, we can see that the stock held the 50-day SMA and the MACD held the zero line (blue ovals). Even though the stock gapped down and held the gap for three days, buying pressure was evident from the long upper shadow on the post-gap candlesticks. These long upper shadows represent the intraday high and show buying pressure. Buying pressure failed to hold into the close, but ultimately gave way to a sharp recovery.

The MACD and the post-gap price action are acting different this time around. Looking at the current post-gap candlesticks, I see little price movement and no buying pressure. The bulls were dealt a setback and cannot recover, a most bearish situation. In addition, the MACD moved below zero and momentum is now negative. The combination of the gap, 50-day SMA break on high volume, and negative MACD is bearish. I now would expect lower prices, and the first downside target is to support around 31. It would take a move above 36.5 to fill the gap, reclaim the 50-day SMA, and revive the bulls.



Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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Date: 04/12/06Rank: 4Comment: 
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