USO - Bullish Island Reversal

(Click On Charts To Enlarge)

posted by Melf Elf @ 7/11/2008 09:43:00 AM

"This morning, USO ripped to the upside at the open, disappointing the shorts, and the 119.17 target got MADE in the first minute of trading."

Rarely do targets get MADE to the exact penny, and even more rarely does that target turn out to be the exact top or bottom, but in this case, that Ascending Triangle target was THE TOP in the USO.

What an interesting chart this is! Lots of good lessons here. We'll start with the H&S Top pattern, late 2007-early 2008:

1. Head & Shoulders Top: It's tempting to get short a pattern like that, particularly in the Right Shoulder, right before the pattern is ready to break down. Stop: the high of the Right Shoulder, which was 73.43.

But, what if it the pattern doesn't break down? If the high of the Right Shoulder gets taken out to the upside (we had that very thing in the 1-Minute chart of the SSO that I posted yesterday), that's a very good indication that the pattern might resolve to the upside, which is why it's a real good idea to cover a short position there, and even got long with a stop below the neckline.

If the high of the Head gets taken out to the upside, the shorts are in trouble on the UPSIDE breakout of the pattern. If they get stubborn and don't cover their short, they can get dragged a lot higher, as we can see in the chart.

For the upside target, measure the distance from the Head straight down to where the neckline was when the high was made that day, and ADD it to the high. That put a target of 89.65 IN PLAY. (If the pattern had broken down, we would have subtracted the height of the pattern from the neckline).

After the upside breakout, the USO came back toward the high of the head and found support there before going on its upside rampage through the channel in blue. That kind of validation of "former resistance acting as support" is ver-ry nice confirmation of the upside breakout.

2. The Channel: Notice that there were three "hits" to the top of the channel, and four "hits" to the bottom of the channel. Those are validated trendlines (3 or more "hits") suggesting that a break of either one "should be" meaningful (there never are any guarantees).

After the 119.17 target got MADE, the USO broke below the channel three days later. At that point, look for horizontal support at the lows that were made in the channel. In this case, the USO found some support near the low at Black #2. Draw a trendline across the chart connecting those two lows, and see if anything happens later on.

3. Symmetrical Triangle - Off that support, the USO had a rally and formed a Symmetrical Triangle. When it broke to the downside, it provided A LOT of information. It not only gapped below that pattern, it gapped below horizontal support, as well. At that point, the Symmetrical Triangle sure looks like the Right Shoulder of a H&S Top, and the Left Shoulder would over in the channel (I should have circled those...ask if that isn't clear). The horizontal black line is the neckline. That put a target of roughly 59.00 IN PLAY (Subtract the distance from the Head to the neckline, then subtract that from where the neckline was when the Breakaway Gap to the downside occured.

4. Gaps - We talked yesterday in the comment section about gap retracements. Breakaway Gaps like this one on October 2 usually don't get filled for a long time. Longs waiting for a fill of that gap to get out of the stock never get the chance, and everyone who still owns the stock above 88-89 is trapped, and becomes "the dreaded bagholder" (that's such an unkind term, but it is descriptive).

Lesson: When serious support gets taken out on an UGLY gap down like that, don't hang on. SELL.

5. Failed Retest - "Bear markets descend on a cushion of hope." When the USO rallied off the 72.95 low, everyone who is trapped above the black horizontal line is "hoping beyond hope" that the stock will continue higher so that they can get out even, and it usually is "beyond hope." They seldom get a chance, and they didn't get one in this case unless they were very quick about it. The rally failed at 89.16, below the 89.63 low of the Symmetrical Triangle (little pattern in red).

We'll move down to Chart #2 now.

6. Bearish Island Reversal - the USO had gapped up on that final move to resistance. It spent five days struggling to get back through there. It finally failed on a gap down, leaving a Bearish Island Reversal there, right below resistance. Anyone who got long there was standed on the "island" of five days' trading.

7. The Falling Knife - During a waterfall decline like the USO had after the Bearish Island Reversal, it isn't a good idea to step in front of it, even if we feel that something is cheap. "Cheap can get A LOT cheaper," as we can see here. It's better to wait until the stock/fund/index does something bullish.

8. Bullish Island Reversal - Yesterday was the first time since the top that the USO did anything bullish, and it still might not end up bullish. Last Friday, the USO had a gap down. On Monday, the USO put in a Bullish Inverted Hammer, then on Tuesday, it put in a Bullish Hammer. Those only are bullish with upside confirmation, which we got yesterday on the Bullish Island Reversal. The three prior days form a little "island" of prices that are detached from the preceding prices and are detached from yesterday's prices.

The high of the island is 53.92. Yesterday the USO gapped up to 54.39, pulled back to 53.94 leaving a gap of only ONE PENNY (53.93), then rallied some more. No one should be allowed to have the USO at those "island prices" of 53.92 and below. If that gap of one penny, at 53.93, gets filled, this is MUCH, MUCH less bullish than it appears to be at the moment, because it then would not be a Bullish Island Reversal.

Sorry for any mistakes. I'm running late and will proofread later.