Chart of the week: A bombed-out share to rally

By John C Burford, author of Tramline Trading, and editor of MoneyWeek Trader

In these weekly articles, I will highlight a share that I believe has an interesting chart pattern. I am primarily a technical trader and use the methods I have developed that I call Tramline Trading. You can read more about my methods in my book Tramline Trading, which you can inspect here.

Most traders and investors make classic errors by chasing a stock near a top and then hang on to it too long during the decline. You will vastly improve your performance by timing your entries and exits more expertly - and that is what I hope to help you with.

My goal in these articles is to cover a share that has an interesting chart. I developed my tramline system over several years to give me a set of rules which can provide me with trade entries at low risk. The low risk requirement was crucially important because no matter how firmly I believe in my trade, I could be wrong! And I wanted my wrong trades to hand me the smallest possible loss to my account. I figured the winners would take care of themselves.

My hope is that you glean useful ideas and employ at least some technical analysis to bolster your returns. In trading as well as investing, timing is a key factor in your eventual returns.

Is the Sky falling?

That was the question I posed in "Chart of the week" of August 10. And this was the chart then:

(click to enlarge)

I had an almost textbook tramline pair combined with an impressive A-B-C rally off the 2009 low. Recall, an A-B-C pattern is counter the main one-larger trend - in this case down. So when the market was hitting the upper tramline in the 1,150p area in late July/early August period, that was a clear warning to look for a major top and for traders to look for short trades, while investors were wise to look to take profits.

And this was the short-term picture on the daily chart:

(click to enlarge)

The rally off the lower tramline was in a clear five up pattern which indicated the rally was about over. Adventurous traders would have been entering short trades at or near the wave 5 high in the 1150 region.

So let's fast forward to this morning and see whether the market has made it to my first major target on the lower tramline:

(click to enlarge)

In fact, it is about half way there! I have a lovely smaller tramline pair (tan lines) and last week, the lower line was broken in a bearish display (and took out the chart support at the 1000 level).

The market is now heading for my original target on the lower green tramline. But already, the market is off by over 10% from the high.

So to answer my question: Yes, the Sky is falling.

Investors are also switching off ITV

Also on August 10, I showed this chart of ITV:

(click to enlarge)

I noted that if the lower tan line of my ending diagonal pattern could be breached, that would confirm the top and herald a bear trend. And that message would be reinforced if the long-term lower tramline was also broken.

So let's take a look at the position this morning:

(click to enlarge)

In August, the market broke below both the lower wedge line and the lower long-term tramline - a very bearish development. And note the selling took the market right to T3, my third tramline which I always draw whenever a tramline is convincingly broken. T3 is drawn equidistant and is always where I set my first major target.

This is a wonderful yet very simple method for taking short-term profits if so desired.

Looking for a bombed-out share? Take a look at Glencore.

If, like me, you adhere to the age-old rule of investing - buy low and sell higher - then Glencore should be on your hit list. This company is at the heart of global commodity trading, and we all know where commodities have been lately.

But with the common assumption that commodities can only go down, I have my Contrary Indicator antennae twitching as the shares are trading at only 25% of its issue price.

Incidentally, at the time of the launch, I believed then that the owners were making one of the smartest investment decisions of the decade - unloading shares near the top of the commodity cycle. Commodity prices were flying high with Chinese demand appearing insatiable. But an analysis of China's economy which was based on unlimited borrowings (and cities with no people) was unsustainable and it was only a question of time before commodity demand would plummet.

But have they sunk too far? Here is the chart:

(click to enlarge)

Note the waterfall cascade off the 300 high back in April. There has only been one single up week since then - it is a sea of red. Not only that, but short interest has been rising since July near today's lows. That short interest could be the fuel for a short squeeze and drive the market much higher. The dominoes are in place for a surprise for the shorts.

Here is the daily:

(click to enlarge)

It shows the accelerating decline since April/May but note the very big momentum divergence. This tells me that the selling is drying up and to expect buying to emerge.

This may not be the low, but it cannot be too far away. The 75% decline since IPO is also very close to the Fibonacci 78% level, which represents solid support.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.