The Gilmo Report

December 25, 2016

December 24, 2016

While this report might be dated for Christmas Day, I can guarantee you that I’m not actually writing this on what is always a big holiday for my family. For those of you who do celebrate it, allow me to wish you a very Merry Christmas. Let me also include a “Happy Hanukkah” and a “Happy Kwanzaa” for those of you who celebrate those holidays at this same time of the year.

Meanwhile, the market isn’t really celebrating anything, other than the fact that Dow 20,000 remains an elusive number. Frankly, it strikes me as somewhat odd that the Dow Jones Industrial Index can come to about 13 points of that price level and the powers that be (translation: the algos) can’t gas it to 20,000. Go figure.

Either it means that there isn’t enough gas left in the tank or it’s just pausing to catch its breath before jumping over the illusory wall of 20,000. If it’s the former, then institutions may be using the magic number as something to dangle in front of late investors to whom they are distributing their stock. If it’s the latter, then I would expect to see some juicy long set-ups start hitting my screens.

In this regard, there isn’t much that makes my trader’s blood boil here in either direction in terms of situations that may have big longer-term potential, at least not at this precise moment in time. Most movements, long or short, have tended to be ephemeral, but good for some scalps. At the same time, one can easily end up on the wrong side of any trade as things seem to mostly chop around.

Lately I’ve been fond of saying that as we move into the past few days of the year what you do is probably less important than what you don’t do. And trying to squeeze blood from a turnip is one of those things you don’t want to do. So outside of some short-term trades, I’m trying to keep things light and mellow as we move through the holidays and closer to the New Year. But I’m looking for that to change, one way or the other, as the New Year begins.

The Dow’s failure to clear 20,000 right away has the pundits and media talking heads backing off a bit from their predictions of just when it might occur. Some are counseling patience, while others are saying it isn’t a sure thing. Funny, it seemed like it was in the bank just a few days ago.

But whatever the ultimate resolution is, the bottom line is that if we look at a daily chart of the Dow Jones Industrial Index we can see that it is merely forming a tight flag formation as it meets up with the 10-day moving average and holiday volume slows to a crawl. With investors perhaps less intent on watching the pot, maybe now the water will finally boil.

 

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On its face the Dow daily chart looks bullish, so perhaps Dow 20,000 isn’t that far off, and all those baseball caps that have been printed up can finally be put to good use! Going into year-end, a move toward the 20,000 level or beyond doesn’t strike me as all that much of a stretch. So if you want to play it, figure out which stocks institutions are likely to support next week.

The NASDAQ Composite Index doesn’t look all that different from the Dow or the S&P 500 Index as all three indexes are holding in roughly two-week consolidations along their 10-day moving averages. Despite a couple of distribution days in the mix, things don’t strike me as all that bearish. So, again, we could easily see a nice melt-up move going into year-end this Friday. The question is whether one can make any big, new, and aggressive commitments or whether it will be good for a trade.

 

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For example, last year the indexes began rallying into the final trading day of the year, but fell two days short as they began to roll over on December 30th. A daily chart of the NASDAQ from that period is shown below, and we can see a nice five-out-of-six days up in a row move leading into the 30th. But that rally ended abruptly and led to a sharp correction in January 2016 before the index bottomed in late January, undercut that low in early February, and then began to rally again.

 

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Interestingly, the same exact sort of thing occurred in the NASDAQ at the end of 2014. After a short, sharp mid-month correction in December, the index then rebounded sharply and rallied right up into year-end. It even logged a new closing high with two trading days left in 2014. At that point it broke sharply for five trading days, with the first two days of that decline occurring on December 30th and 31st, 2014. That led to the formation of a choppy range before the index finally settled down and broke out of the range in early February.

 

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While December 2014 and 2015 both saw year-end rallies end with sharp sell-offs that carried into the New Year, 2013 was quite the opposite. The NASDAQ rallied to a higher high in mid-December, but as it made the move into the final trading week of the year, it gapped down and sold off for five straight days. On the final trading day of the year, December 31st, the index suddenly did an about-face and reversed sharply back to the upside. This then led to a big gap-up open on the first day of trading in 2014, and the market embarked on a decent upside rally from there.

 

gr122516-compq-2013

 

So the evidence of the past three years seems to indicate that the market will start the New Year out moving in the opposite direction to how it finished out the prior year. Of course, this “market study” is based on a statistical sample size of only three data points.

If you’re going to assume that we are in a new bull market, then recent breakouts that are pulling back would be of interest. One example among stocks I’ve been discussing on the long side in recent reports is The Trade Desk (TTD). The stock is currently pulling into its 10-day moving average and its prior trendline breakout point on light volume.

This would put the stock in a lower-risk buy position using the 10-day line at 29.65 as a tight selling guide. For new members, allow me to define what I mean by “selling guide.” When I use that phrase I mean the reference point given, in this case the 10-day line at 29.65, plus another 1-3% of downside porosity (otherwise known as a small movement below the line, which can often be temporary).

Depending on one’s risk-preferences, one can use the 10-day line as a hard stop, which would be very tight, or a wider stop that allows for the stock to dip temporarily anywhere from 1-3% below the 10-day line.

 

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Impinj (PI) is pulling into the top of its recent base breakout point on declining volume, which brings it into a potential lower-risk entry point. While the top of the base, as I’ve highlighted it in yellow on the chart, can be seen as a potential area of support, we might consider the 10-day line as another potential area of support on any further pullback from current price levels.

PI does have a tendency to be somewhat volatile, and generally pullbacks to the 10-day line are more reliable entry points than the tops of a prior breakout. We can see how this worked on the prior trendline breakout in early December. The stock pulled back below the actual breakout point but held on the pullback to the 10-day line over the next several days as volume declined to voodoo levels or -35% below average or more.

The 10-day line is about 8% below Friday’s close, but is rising rapidly and is now at 35.65. My guess is that if PI were to pull back further it would likely meet up with the 10-day line at a price that is higher than the current 35.65, perhaps in the 36-37 price area. I would look to use such pullbacks on light volume as lower-risk entry opportunities, should they occur.

 

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Everbridge (EVBG) is another newer-merchandise name I’ve been following on the long side in recent reports, and it recently broke out of its first IPO base seven trading days ago. That move got a little bit extended, but this current pullback to the 10-day moving average brings it into a lower-risk buy position.

Note how volume dried up in the extreme on Thursday, but then picked up slightly on Friday in a show of supporting action at the 10-day line. So here we have a lower-risk entry at the 10-day line at 19.04, using it or the top of the base just above the 18 price level as a reasonably tight selling guide. My opportunistic preference, if I could get it, would be to look to buy into a pullback down as far as the 20-day line, now at 18.07, which more or less coincides with the top of the base.

 

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Square (SQ) is dipping below its 10-day moving average here as volume dries up sharply. I wouldn’t be too concerned with the fact that it can’t hold above the 10-day line given that the stock is well-extended after a roughly 17.7% price rise over the past month or so. With the 20-day moving average now at 13.71 and above the 13.40 intraday low of the prior mini-buyable gap-up (mini-BGU), pullbacks to that price level would probably offer the most opportunistic entries. That would be my preferred entry point should it occur.

 

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Twilio (TWLO) turned out to be a one-day wonder trade after Wednesday’s massive-volume bottom-fishing pocket pivot (BFPP) coming up off the 10-day moving average and up through the 20-day line. As I wrote on Wednesday, we might expect the stock to run into some resistance at the 50-day moving average, which is what we saw on Thursday.

That reversal was a fairly severe one, however, as it came on selling volume that was heavier than the prior day’s BFPP. The ephemeral nature of Wednesday’s move was perhaps not too surprising given that it occurred on news that TWLO was expanding its relationship with Amazon.com (AMZN).

However, as I pointed out in my Wednesday report, I would not be buying into the big price move of that day. I would instead like to see how the stock handles any pullback to the 20-day moving average. As it turned out, Thursday’s massive-volume selling saw no follow-through on Friday. Instead, volume dried up sharply as TWLO was able to hold the 20-day moving average. For the adventurous trader, taking a position here just above the 20-day line at 31.70 is possible, with the idea of using the line as a tight selling guide if things don’t work out.

 

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Amazon.com (AMZN) has flipped back below its 20-day moving average on light volume. The stock got weak on Thursday after it was reported that holiday sales are down -4% from last year at this time. While I can see the stock reacting in the short-term to such news, the bottom line is that the forward-looking driving force for AMZN remains its cloud business.

As I wrote on Wednesday, I would not want to see the stock bust the lower trendline of this current triangular pennant formation on heavy selling volume, as that would bring the stock into play as a short-sale target. Technically, one could even consider the stock a short here using the 20-day line as a guide for an upside stop. But AMZN has shown a tendency to experience some “porosity” around the 20-day line, so heading into year-end I would not be surprised to see the stock regain the line if it gets supported by institutions.

 

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I continue to think that Facebook (FB) is likely to find some institutional support going into year-end, and for that reason may be good for a trade up to or even beyond the 200-day moving average. So far this has proven to be wishful thinking, but notice that the stock did undercut the prior December low on Friday, which could set up a small undercut & rally move from here.

For those of you who follow me on Twitter (which I hope most of you do), I was discussing the “MACD stretch” on the 620 intraday chart that I was seeing early in the day. That actually set up a buyable pullback as the stock flopped around the 116.50 price level, and by the close FB was back above 117.

So from here I’d use the Friday low at 116.30 as a tight selling guide while looking for the stock to rally back above the 117.61 low of December 13th which would help to confirm it as a possible undercut & rally set-up. If it works it’s probably good for a swing-trade, but maybe not much more. That all would depend on whether we see some strong volume propel the stock back above the 200-day moving average over the next few days.

 

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Netflix (NFLX) looks squeaky tight here as it pulls into its 10-day moving average on an extreme voodoo volume signature that was -77.5% below average. This puts the stock in a buyable position using the 10-day line at 124.75 as a very tight selling guide.

 

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Qualcomm (QCOM) remains in an L-shaped formation as it continues to track just below its 50-day moving average with volume drying up. With respect to its position relative to the 50-day moving average, QCOM looks like a possible base-failure, short-sale set-up situation. But with respect to its overall base extending back to early October, it is still sitting within the confines of what is now a three-month base.

For that reason, I think one has to be open to the stock resolving this particular pattern in either direction, depending on how things play out. As we move into year-end it could find some institutional support, and the first sign of this would likely be a move back up through the 50-day line on increased buying volume. So far selling volume has remained light since the last high-volume breach of the 50-day line six trading days ago on the chart, which indicates that sellers aren’t in a hurry to unload shares at this particular place and time.

 

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Martin Marietta Materials (MLM) is setting up in a very tight six-week base here following its early November buyable gap-up (BGU) move right after the election. While the stock hasn’t moved much at all since the BGU day, it has continued to set-up constructively.

If we consider the fact that the BGU move came at the tail-end of a move that began near the 180 price level, over 20% lower, then the time spent consolidating those sharp gains appears reasonable. I look at this as being buyable here using the 20-day line plus about 2% of downside porosity as a reasonably tight selling guide.

 

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Delta Airlines (DAL) was holding tight along its 10-day moving average on Wednesday, which gave it the appearance of wanting to move higher. On Thursday the stock made a move down toward its 20-day moving average on higher selling volume, albeit still below average.

The key here, however, is whether the stock can hold the 20-day line. A breach of the 20-day line would bring the stock into play as a short-sale target. However, DAL has had a nice move over the past couple of months, and it may be an institutional favorite that gets supported into year-end. In this case, the pullback to the 20-day line might present a lower-risk entry opportunity, using the line at 49.54 as a tight selling guide.

 

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Oil stocks have remained somewhat down and out following their big gap-up moves in late November in the wake of the announcement of the OPEC production limits agreement. Continental Resources (CLR) has been on my radar as a potential late-stage, failed-base short-sale set-up, but so far has not breached the 50-day moving average despite dipping just below the 20-day line.

The stock appears to be perking up a bit here as my indicator bars along the top of the chart become more blue. This brings up the possibility of a tradeable move off the 50-day line. In this case, you simply buy the stock here with the idea of using the line at 51.43 as your selling guide.

 

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Steel Dynamics (STLD) is one of the top steel producers coming through my screens currently, but I have to admit I should have come after this on the buyable gap-up move back in early November. Having said that, the next entry to look for would be on a constructive consolidation of the gains it has had since then.

Here we see STLD pulling into and holding tight along its 20-day moving average as volume dries up. This would put it in a lower-risk entry position using the 20-day line at 36.39 as a tight selling guide. I would look for the stock to perhaps be supported going into year-end, and so this would be your best entry as we move into the final trading week of the year.

Of all the steel stocks, STLD has the most consistent fundamentals. Over the past three quarters earnings have grown 53%, 164% and 160%, sequentially, while corresponding quarterly sales growth has turned around from -15% to 1% and 8%.

 

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Ciena (CIEN) is acting well after finding support at its 10-day moving average last week. That led to a nice upside move back toward the prior BGU highs where the stock is now building this little mini-cup and handle formation. This actually looks buyable using the 10-day line at 241.5 as a tight selling guide, or the 20-day line at 23.40 as a wider selling guide.

 

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CIEN’s cousin, Finisar (FNSR) still looks weak as it was not able to sustain a bounce back above the 20-day line on Thursday. I actually tested a short up around the 32.30 price level to get a feel for the stock and was surprised at how easily it backed down and ended the day slightly in the red.

Volume remained light, however, as the stock held above the 50-day moving average, which I suppose is somewhat in the stock’s favor here. Sometimes these types of “LUie” set-ups take time to develop, and it may be that the stock will continue to track along the 50-day line before it can mount any kind of meaningful retest of the prior highs. The flip side is, of course, the possibility that FNSR busts the 50-day line on heavy volume, which would cause the stock to morph into a short-sale target. That is something to watch for in the coming days.

 

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Another cousin-stock to CIEN and FNSR is Lumentum Holdings (LITE), which is in a similar position to FNSR as it holds tightly along its 50-day moving average. Like FNSR, LITE also tried to blast higher earlier on a breakout attempt in early December, but failed. Now it is more or less sitting on the fence here along the 50-day line as volume dries up in the extreme. I’d have to say that in the old days, given all the high-volume selling in the pattern since early October, I would categorize this as a weak base.

But nowadays anything is possible, and with the stock tracking tightly along the 50-day line, it could just as easily resolve to the upside. Fundamentals remain strong for LITE, and its character has been such that buying it on weakness, or when it looks dicey, is the right thing to do. My take here is that if the stock can hold the 50-day line, it may best be viewed as a long here, using the 50-day line as a tight selling guide. If it busts the 50-day line on volume, however, it immediately morphs into a short-sale target.

 

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If the Dow is able to push toward 20,000 this coming week, then we might look at something like Caterpillar (CAT) as less of a short and more of a possible long trade. Last week the stock started to roll back below its 20-day moving average, which led me to view it as a possible short, but it was able to find support near its 50-day moving average.

While the stock didn’t actually touch the 50-day line, it did hit the 10-week moving average on the weekly chart. This led to a bounce back to the upside on higher, although below-average, volume. CAT has since been able to retake its 20-day moving average and is holding excruciatingly tightly along its 20-day moving average. If the Dow makes a run for 20,000 this coming week, look for CAT to push back up toward its early December highs.

 

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I know at least a couple of members have expressed the view that bio-techs will start to come on again, and I certainly won’t argue with that premise IF I start to see some long set-ups in the bio-tech space start to hit my screens. Interestingly, a small bio-tech I’ve discussed in previous reports is doing just that.

Myovant Sciences (MYOV) went into hibernation after a strong upside move in late November. At that point, the stock backed down to whence it came, just under the 11 price level and along the lows of its current IPO base. It’s fairly clear that somebody likes this stock at these prices given the big-volume pocket pivot we see six trading days ago on the chart below.

That led to a tight consolidation just along and below the 10-day moving average before Friday’s pocket pivot move back above both the 10-day and 20-day lines. In my view this puts the stock in a buyable position using the recent lows at around 10.93 as a reasonably tight selling guide for a stock this small. Keep in mind that MYOV trades about 310,000 shares a day on average, so it is relatively thin.

 

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Tesla Motors (TSLA) is proving to be somewhat tenacious in what is now its third attempt to clear its 200-day moving average over the past three months. This latest attempt was triggered by a bottom-fishing pocket pivot (BFPP) two weeks ago. After reversing near the 200-day line on Wednesday on heavy selling volume, TSLA picked itself up and made another run for the line on Friday.

Volume came in at about average, which is actually somewhat impressive given the slow, pre-holiday trade seen in most other stocks. With this third attempt at clearing both the 200-day line on the daily chart and the 40-week line on the weekly chart, perhaps the “Rule of Three” will come into play. If it does, then we might expect this latest move to the 200-day line to fake out the crowd and clear to higher highs.

In my view, the main factor working in TSLA’s favor is the high short-interest (nearly 25% of the float) and the crowd’s view that an incoming Trump Administration is a big negative for the electric car industry. Certainly, a Trump Administration isn’t likely to foster Elon Musk’s status as a true crony capitalist who has relied on government largesse, subsidies, and favorable regulation to move his car company forward.

But that doesn’t mean shorts can’t be squeezed harder if the stock gathers some upside momentum. That said, the number of percentage points the stock has rallied from the 50-day line is still only about 10%, and in this market sometimes that’s all you get.

My general view of TSLA is that it will eventually sell for far less than it sells for now, but that doesn’t mean it can’t rally further from here. And if it can clear the 200-day moving average it could send the shorts scrambling. Otherwise another failure and reversal at the line could seal its fate as a short-sale target once again.

 

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My expectation is that we will likely see the market rally in the final week of 2016, and Dow 20,000 will become a reality. For this reason, I am not all that hot about trying to short stocks over the next week. In addition, I don’t see much that is in what I would call full breakdown mode.

Northrop Grumman (NOC) and other defense stocks have had the look of being in breakdown mode as they all gapped down to or below their 50-day moving averages about two weeks ago. So far, none of these names, which include Lockheed Martin (LMT) and Raytheon (RTN), have come apart in any meaningful way.

I’ve been watching all of these defense names trade over the past couple of weeks, and aside from LMT selling off a little on Thursday when President-elect Trump began talking about getting bids for another jet fighter from Boeing (BA), there hasn’t been much movement in any of these.

For this reason, I’m beginning to suspect that this will turn out as “LUie” set-ups where the stocks hover around and just below their 50-day line in tight fashion before making a move back to the upside. For this reason, I’m less keen on trying to short these, particularly as we move into this final week of trading for the year. As I wrote earlier, sometimes it’s not what you do that matters, but what you don’t do.

 

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I wanted to finish off this Christmas Day report with a discussion of a topic that actually comes up quite often in emails. It is a frequent question, and it has to do with this idea of a high, tight flag base formation. I would say of all the questions I get, those that are phrased as “Does XYZ qualify as a high, tight flag?” or “Is XYZ forming a high, tight flag?” is one of the more frequent ones.

First of all, if you refer to the most current edition of my old boss and mentor William J. O’Neil’s investment “bible,” How to Make Money in Stocks, you will note that the section regarding high, tight flags starts out by stating that these patterns are rare. In fact, they are so rare, that of the 15 examples they show in the book, about half are from the 1960’s or earlier.

What is even rarer, however, is the statistical reliability of these patterns as “sure thing” bullish formations. They are not, and in fact, if you actually study all (or at least a statistically significant sample size) of these patterns, you will find that most end up in failure. Allow me to show one recent example, without immediately giving away the name of the stock.

Here we see a flag formation that looks very tight, and has all the positive characteristics we might be looking for, according to the definition of an “HTF” in How to Make Money in Stocks. If you’ve looked at the scant 15 examples of HFTs in the book, this pattern might get you salivating as you naively anticipate 100% gains from here!

 

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But if you had simply bought this on the basis of being able to label it a “high, tight flag,” you would have ended up sorely disappointed. And that would be because the HTF ended up failing miserably as the stock, Acacia Communications (ACIA) ended up getting cut in half after forming the “amazing” HTF base formation.

 

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In true scientific analysis, a premise is immediately proven wrong by opposing evidence to the contrary. In true statistical analysis, sample sizes of 10-15 data points or examples are statistically insignificant, end of story. In ACIA’s case trying to pin a label on the pattern as the stock held up around 120 a share earlier this year had zero predictive value. This is why such labels are useless.

Personally, I could care less what you label a pattern, as I am only interested in the precise real-time price and price/volume action. I use things like pocket pivots, bottom-fishing pocket pivots, roundabout pocket pivots, undercut & rally moves, voodoo pullbacks, and other more precise price and price/volume signatures to figure out where things might be headed.

The primary issue I have with the whole discussion about HTFs is that they only serve to create a mythical impression in investors’ heads that somehow an HTF pattern, if you can label something as such, is a magical road to riches. It is not, and I can tell you that most of these patterns are prone to failure.

This is particularly true in a range-bound general market environment such as we have been in during 2016. As I’ve discussed many times in my reports over the past year, these upside moves do not go to infinity, and there is a point at which they become somewhat stretched on the upside. In a much stronger general market uptrend, such as was seen in the 1960’s and the 1990’s, these patterns, as with all patterns, might have a greater probability of working, but relying on them as a heuristic crutch can be fatal.

During 2016 I received a number of emails asking me if ACIA was a high, tight flag, as well as TWLO, which I show below on a weekly chart. Here we see the stock actually try and break out from the HTF, but that does not lead to instant 100% upside gains. Instead, it leads to a massive collapse in the stock price that essentially retraces nearly all of the prior upside move.

 

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I often like to say that there is nothing more dangerous than a little knowledge. When it comes to this HTF concept, that proves to be quite true, as it has in 2016 in more than a few examples. The bottom line is that you don’t need to label something an HTF, all you need to do is understand the precise price and price/volume action you are seeing in real-time, no matter what the macro-pattern looks like.

My goal, as one who is merely carrying on and refining the work of my great predecessors, William J. O’Neil, Richard D. Wyckoff, and Jesse Livermore, is to develop more precise methods and tools within the spirit of the overall investment philosophy I call the “OWL,” which reflects the investment wisdom of the “O’Neil-Wyckoff-Livermore” triad.

Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and Principal, Virtue of Selfish Investing, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC held a position in TWLO, though positions are subject to change at any time and without notice.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.