Sell in May and Go Away?

[PristineTrading 10]

The prior Chart of the Week (COTW) dated May 20th was titled "Ripe for Breakout Failures." In it, I showed you a couple of breakout failures and I gave you a few stocks to watch including the S&P 500 ETF symbol SPY. Break-out failures (BOF) are all over the place now and are obvious to even the most novice chart reader. Pristine students, and hopefully you as a reader of these COTW lessons were prepared for the moves lower that have occurred since that time. Many of the daily Break-Out Failures (BOF) have now formed monthly Topping Tails (TT) in May, so let's look at a few and the differences in how they have formed.

 

A Topping Tail (TT) is a signal that buying (demand) was not strong enough to overcome selling (supply) at the high of the range, so prices fell. This can often signal that the end of a long-term uptrend is at hand when the TT forms on the monthly time frame. However, the truth is that we really never know when an uptrend is no longer an uptrend until it doesn't meet the definition of one; higher highs (HH) and higher lows (HL). That being said, with the signal of a monthly TT, those educated in the proper use of multiple time frames analysis can find excellent "swing-trading" and "day-trading" opportunities.

 

Let's look at some different chart patterns with monthly TTs.

 

Before we review the charts, here is some food for thought for those of you are not Pristine Students, yet and are in search for the truth when it comes to understanding technical analysis. I said above that the definition of an uptrend no longer being in effect is a simple way of knowing that an uptrend no longer exists. It's that simple, but virtually every commercial we see to open an "online trading" account (they seem to be endless) and from those that tell you they can teach you how to use technical analysis will show you a break of an uptrend trend line, a moving average, a retracement level or any of the other technical trend tools used to do it. Also added are some of the hundreds indicators that come with an endless combination of settings. All of these are often meaningless as a guide to a trend break and are outright misleading. Sometimes, it may even look like they got it right because the definition was violated at the time (e.g. the break below a prior low)

 

Why do so many use these indicators? I assume it's because that is what they were taught and they never seriously questioned why those indicators fail as a guide so often. Why do the brokers wanting you to open an account with them show these? First, most actually know nothing about the technical analysis tools in the platforms they offer. To them more is better compared to than what the competition may have. They also want you to believe software can make you money. An educated, disciplined investor or trader - with a plan - can make money with any charting software. Let's continue.

 

 

The TTs in the above charts all formed after what we refer to as a "fluid move" higher. Fluid moves have continuous higher high (HH) and higher low (HL) candles and these preceded the TT. This type of price move is the strongest possible and displays the most certainty about the buyers' view on the stock. This is the type of trend you want to buy on the pullback in anticipation of a higher swing low to be followed by a higher high in the trend. Realize that the lower time frames will not look good to the untrained eye at the time the monthly swing low is forming. That is when the knowledge of how to use multiple time frames will benefit you most. Without it, you'll miss a big part of the move.

 

 

Here price have spent time moving sideways before the TT formed, so there is a larger area of supply (caught buyers) above. These can also form a higher swing low on a pullback, but these highs tend to be more difficult to overcome. The uptrend has not been violated on any of these, so keep them on your watch list.

 

 

The TTs within a range tend to continue the erratic price action that has been happening. Red Hat (RHT) has the largest TT compared to its most recent price ranges. For that reason, it has higher odds of testing the bottom of the range. Notice that BRCM has an opposing Bottoming Tail (BT) that is significantly larger than the TT. This suggests that BRCM is least likely to move to the bottom of the range. YUM Brands (YUM) is more neutral since its TT is inside the range of the prior candles. YUM could be a breakout play higher if it stays at the top of the range during a market correction (i.e. relative strength).

 

 

 

These two TTs have formed after a breakout above their resistance areas and failed to hold onto the move higher. A breakout above resistance followed by prices falling back to the breakout point historically will result in more selling. Everyone that bought the breakout as well as points inside that TT candle are now holding a loss and are likely to sell on any further weakness. United Parcel Service (UPS) is likely to see more selling pressure than BEAM if it moves below the prior candle's low, which was a BT candle. The reason for that is because of how it moved up from the 2012 low (star). UPS moved up in a "fluid" arrangement of HH - HL candles whereas BEAM move up, but within a sideways to upward motion.

 

You're most likely thinking, "but UPS was the stronger move up, so why would it be likely to see more selling pressure?" That's an excellent question. The answer is because fluid price moves like seen in UPS leave little to no support reference points for traders to use as new buy points if prices pull back. In addition, the BOF in UPS was preceded by a continuation buy signal. BEAM on the other hand has many overlapping candles that display a higher level of uncertainty.

 

Another way of understanding the traders' expectations within these patterns is this: The UPS price move up (fast and fluid) is virtually a sure thing (trade) to continue its move higher. The BEAM move up (slow and overlapping) should move higher, but a stall would not be a big surprise since that is how it has been moving all along. The TT candle in both has changed that to different degrees. Buyers of UPS are shocked to see its continuation of the prior strong move result in a TT.

 

Pristine Tip: Technical Analysis of current price movement and the patterns that preceded it is a representation of the thoughts, beliefs and expectations of all those that created the chart. This includes independent traders, investors, hedge fund managers, money managers, those running auto-trading computers, etc.

 

 

Lastly, the TT candles in these stocks are also in the process of making lower highs. A move under the respective TT candles lows will begin to establish those lower highs. Each stock fell relatively hard in 2012. Notice the large red candles and the weak recovery in 2013. Clearly, these stocks have shown relative weakness and have higher odds of falling to their prior lows, and potentially below them to make lower lows.

 

The month of May has produced many Topping Tails (TT) candles that have signaled increased selling pressure. As you have read and viewed, the knowledge of a TT without an understanding of the price action that preceded it is close to no knowledge at all. Having some knowledge may be even worse than no knowledge at all, since you are likely to use that information incorrectly and potentially lose a lot of money. Isn't that what we all do when starting out?

 

As you can see, TT candles can and do come with many different arrangements of patterns and the reaction to that TT will be different based on those different patterns. In addition, there are other technical factors to consider like volume, prior support and resistance, market environment at the time, sector rotation, multiple time frame analysis, relative strength or weakness, market internals and more. At Pristine, we teach all of these and most importantly how to combine their information together to find high probability investing, swing-trading and day-trading opportunities.

 

 

All the best,

 

 

Greg Capra

President & CEO

Pristine Capital Holdings, Inc.