Interactive Investor

Chart of the week: Watch this breakout

23rd May 2016 13:02

John Burford from interactive investor


Update on Aviva

With this mammoth insurance company in today's news, in that it has (or will) divest itself of tobacco-related investments in an apparent show of political correctness, I thought I would update my coverage of it from 7 March when I featured it in a Chart of the Week.

Actually, maybe the investment managers believe sin shares have had their day, despite their relatively good dividends. Maybe the plain cigarette packaging rules just introduced in the UK were the last straw (although UK consumption has been flat or declining for years).

A case in point: Imperial Brands has been in a relentless bull run since the 2013 lows at 2,100p with a recent 3,800p quote. Perhaps Aviva suspect a pullback and wish to take profits. We shall never know, but we can have suspicions.

And my interest was sparked, as always, by the patterns on the charts. This is Aviva's 10-year chart I showed in March:

This was a classic "five down/three up to the Fibonacci 62%" pattern that I am always on the hunt for. It is a beautiful example of Elliott waves - and the key point here is that the C wave top offers a high-probability, low-risk shorting opportunity. But you must be alert to capture it!

In early March, this was a close-up of recent action:

With the C wave high firmly in place, I could then analyse the waves down and also set my new Fibonacci levels on the way down.

The wave three or C sell-off in February took the market to the precise Fibonacci 62% retrace of the purple C wave from the purple B wave low. Also, the September dip took it to the Fibonacci 50% level, where it encountered good support.

Both of these accurate hits on those two major Fibonacci levels is a vivid demonstration of the power of using Mr Fibonacci's mathematics. The crucial point is that the 50% and 62% levels can be drawn in beforehand and allow you to set upcoming price targets for likely reversals - as well as identify where profits can be taken on shorts, if desired.

Also, if you veered towards the A-B-C scenario, that, too, was a great place to take long positions.

From that March low at the 400p level, the market did indeed reverse and had rallied to the 460p area in early March. But was there more left in the tank?

Here is the daily chart updated to this morning:

The vigorous rally carried to the Fibonacci 78% retrace of the red C wave and began a steady decline. Note that the March rally was in a clear three up. Also, the decline off the 500p high also takes the three-wave form - and that could signal a corrective wave and herald a resumption of the uptrend.

And that decline to last week's low carries a mighty momentum divergence (red bar on the momentum scale). I place great significance on momentum divergences.

So, in the space of just a few days, the outlook has switched from bearish to potentially very bullish.

Let's zoom in on the recent action:

The decline off the March high is a clear five down (green bars) and, from Elliott wave theory, we know that when a five-wave motive pattern ends, the market reverses. That flagged reversal took place six days ago at my purple wave two low - and that was the place to take profits on shorts - and gear up for trading long.

Recall this is what I wrote on 7 March:

Now, the market has hit the Fibonacci 38% resistance and is also inside chart resistance from last year's congestion zone, so a pull-back of some kind can be expected. This is where short term trades will be looking to take partial profits on their shorts, especially if spread betting.

So that wave two dip was the best place to cover shorts. But is it a good place to resume long positions?

Outlook

The signs are pretty good, with the tramline break last Thursday on that huge momentum divergence. The key level is the recent highs at around 450p. If the market can break above that level, odds are high for a challenge on the 470-480p resistance.

And if the purple wave one high at 500p can be overcome, that would give me more confidence that a wave three will be underway. But the key level on the downside is the wave two low at 408p. That must hold for my more bullish scenarios to play out.

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