The Gilmo Report

January 4, 2017

January 4, 2017

The market opened up the New Year with some left-over New Year’s Eve fireworks by gapping up sharply yesterday right off the bat. The Dow got up as much as about 178 points before things began to weaken. Once the Dow got down to low double-digits on the plus side, the opening gap-up rally appeared to be in jeopardy.

Watching this unfold, it struck me as the stuff of a potentially spectacular price reversal. A move into the red after such a sharp upside opening would have given the first day of trading in the New Year a peculiar flavor, to be certain. Like the taste of raw bear meat, perhaps. It also would have been more consistent with the weak showing we saw in the indexes over the last 2-3 days of the year last week.

But, the Ugly Duckling is always at play in this market, and that was the case yesterday as the major market indexes held their ground and began to trudge back to the upside later in the day. By the time the closing bell rang, the indexes had all moved back to the upper halves of their intraday trading ranges on higher volume.

This of course looked bullish on the daily charts, and the market accordingly responded with another, but much smaller futures-led gap-up this morning, and held up all day. The NASDAQ Composite Index has now pushed higher over the first two days of the New Year on about average, but higher volume each day.

 

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The S&P 500 Index just missed posting a new all-time closing high today by about a single point. But it has started the New Year with two straight up days on above-average volume. So far the action in 2017 negates the weakness we saw going into year-end last week, and that is a bullish development in the New Year.

 

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While I wouldn’t call this a target-rich environment on either side of the market, there are trades that can be made using the tools at our disposal. In addition, the situation in this regard has improved substantially over the past couple of days. And, of course, in this market, it is always helpful to be mindful of the Ugly Duckling. For those of you who are new to the Gilmo Report, allow me to briefly explain the Ugly Duckling Principle.

If you’ve been involved in this market for any period of time over the past 2-3 years, you would observe (a necessary component of successful speculation) that many times when things look ugly, whether they are indexes or stocks, they can quickly stabilize, set up, and run back to the upside. This has been even more so during the choppy, trendless, and highly rotational environment we’ve seen over at least the past year-and-a-half.

So things that look very much like the proverbial ugly duckling end up magically transforming into beautiful swans! And, as I have observed the Ugly Duckling Principle at work in this market, I have also come up with an associated set of long set-ups that I use to navigate through this type of environment.

Intuitively, we should easily be able to understand how the Ugly Duckling Principle makes complete sense within the context of a range-bound, rotational type of market. Things go to the highs of the range, then they go back down to the lows of the range as money rotates back and forth. Meanwhile, breakouts don’t work, while Ugly Duckling long set-ups and buying methods do.

Among such set-ups that I look for, we have the bottom-fishing pocket pivot (BFPP), the roundabout pocket pivot (RAPP), the bottom-fishing buyable gap-up (BFBGU), the undercut & rally (U&R), and the Wyckoffian Retest. There is also the “That Thing Looks So (Expletive Deleted) Ugly That It Probably Goes Up from Here” set-up, but that’s one I’m not ready to go public with just yet. It relies more on tape-watching and getting a sense that something just might be oversold and ready to rebound.

We can look at a current example to see some Ugly Duckling set-ups in the chart of Mobileye (MBLY) over the past few days. I first tweeted about it on Thursday as a name to look at on the short side into the news rally. But shorting the stock, I quickly gained a visceral feel that this thing did not want to go down. And with 22 million shares sold short against a float of 94 million, that proved to be the case as a lot of shorts were getting squeezed very quickly.

As I was initially looking to short MBLY last Thursday, the visceral feeling I was getting clearly contradicted my initial view. At that point I start looking around for what else might be going on here. The first thing that showed up on my charts was the fact that MBLY was in fact posting a bottom-fishing type of pocket pivot back up through its 50-day moving average.

This was followed by a second pocket pivot coming up through the 200-day moving average. This second pocket pivot was more of a roundabout pocket pivot since the stock is at that point making a more concerted effort to round out the lows of a bottom.

 

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My view here, as I expressed on Twitter (which is why you all also want to follow me on Twitter at @gilmoreport or pay attention to my tweets which are also posted on the main Gilmo Report website page) was that its ability to hold the 50-day moving average was key to the success of last Thursday’s BFPP.  For the adventurous trader, buying at that point and then using the 50-day line as a tight selling guide on an intraday basis was a feasible strategy.

When looking at this sort of set-up it also helps to take a macro-view of the situation by looking at a weekly and/or a wider-view daily chart, such as we see below. Here we can see that MBLY had previously undercut two major lows in its pattern, with the lower of the two occurring in June of 2016 at 33.93.

Seven days ago on the chart, MBLY hit an intraday low of 33.69, undercutting that prior low, and then turned back to the upside. While I would not buy the stock on the basis of this longer-term undercut & rally move, it does add weight to the bullish action seen on both of the pocket pivots that have occurred since then.

 

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For those of you who are deeply inculcated into O’Neil-style methods, keep in mind that all of these methods that I use to buy stocks much, much lower in their patterns and well before obvious base breakouts are rooted in the philosophies of Richard D. Wyckoff and Jesse Livermore. Both of these gentlemen essentially set the foundation for William J. O’Neil’s subsequent work, and along with O’Neil, make up what I call the “OWL™” (O’Neil-Wyckoff-Livermore) methodology.

Things like pivotal points (which for Livermore included mostly reversals, not breakouts), Livermore’s’ true “shakeout-plus-three” rule (which is a bit different than O’Neil’s) and Wyckoff’s “springs” are all part of my buy set-up lexicon. For long-time Gilmo members this is all old news, but my work is always moving forward as I build upon what I’ve learned from my great predecessors, Wyckoff and Livermore (among others) and my direct mentor, Bill O’Neil, for whom and with whom I ran money in the markets for eight years of my life.

In any case, I am a strong believer in the idea that markets are always changing. In the process, they develop new wrinkles that require traders to adjust and adapt their methods. Those that don’t fall by the wayside, and as I am fond of invoking from time to time, “Adapt or die!”

I also don’t subscribe to the idea that the market these days is just “too difficult” and things “just don’t work like they used to.” That’s a cop-out for small thinkers who want to rely on narrow methods that are rigidly mapped out for them in a manner that allows them to avoid thinking for themselves, at least deeply so.

For those of you who adhere strictly to O’Neil orthodoxy I would urge you to open your mind and expand your approach. Those who are deeply invested in belief-systems rather than objective trading methods are most likely to be threatened by the OWL. But trading and investment methods are to be treated at all times like the objective beasts they are: They either work or they don’t.

I believe in what works, and in my view what works is, well, what works. Any honest appraisal of the stock market in the pursuit of understanding “how the market really works” at any given point of time rejects orthodoxy and embraces fact. And the facts show that utilizing a broader array of buy set-ups, methods, tools, and techniques can only make one a better trader. It also provides that special edge that all traders seek in a market where everyone has access to information, including charts, in real-time.

In any case, if you think MBLY is an isolated example of these set-ups, think again. In support of this, just look at a stock I’ve discussed in recent reports and which I featured at the end of my last report as a stock to watch in 2017, Tesla Motors (TSLA).

I first pointed out the pocket pivot at the 50-day moving average on December 13th. This is a classic Ugly Duckling buy set-up because most people won’t believe, including yours truly. But if one sets aside their feelings, and operates solely on the basis of the precise price/volume action at hand, the trade is definitely doable using the 50-day moving average, only a couple of percent lower, as a tight selling guide.

Over the weekend I described the most current action in TSLA as it posted a pocket pivot coming up through the 200-day moving average last Tuesday and then dipped below the 10-day line into year-end as normal given the extension of the move from the 50-day line.

Yesterday TSLA pushed back up through the 200-day line on another pocket pivot move. After-hours they announced their final 2016 sales numbers, and the stock sold off down to 207 in after-hours trade before stabilizing around 212. This morning it opened up at 214.75, pretty much right at the 200-day moving average.

That put it in a lower-risk buy point given that one could simply use the 200-day line as a tight selling guide. The end result was the stock’s third pocket pivot at the 200-day line over the past six trading days on very heavy buying volume! Fee-fi-fo-fum, I smell the blood of the short-seller man!

 

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As I blogged this morning, the high short interest in the stock has been relying on some big piece of bad news to kill TSLA. I also pointed out that if the 2016 final sales numbers couldn’t kill it, they would be scrambling deeper into the woods in search of cover. And so TSLA paused briefly at the 200-day moving average this morning before pushing to higher highs by the close. It sure looks like it wants to go higher, that much I can tell you.

If you’re looking for something more orthodox, then I suppose Netflix (NFLX) gets you closer. However, yesterday’s above-average volume move didn’t qualify as a base breakout. But it did qualify as a pocket pivot move off of the 20-day moving average and up through the 10-day moving average.

That alone was buyable, and the stock briefly tested the 10-day line this morning before turning higher on what was a bona fide pocket pivot breakout to higher highs. The volume might be enough for orthodox base breakout buyers, but we know that a breakout on a pocket pivot volume signature can work. At the very least, yesterday’s pocket pivot would have gotten you in earlier, so you’d be ahead of the game today.

The only fly in the ointment, so to speak, is that NFLX is expected to announce earnings on January 18th. For that reason, it’s not clear to me that I’d want to be venturing into the stock ahead of the report. If I did, I would be looking for a decent price move before earnings, and then based on any profit cushion that is generated by such a move, I may or may not decide to play earnings roulette. In general, however, my preference is to avoid the spin of the wheel by having no position going into an earnings report unless I have a fairly significant profit cushion.

 

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Yesterday after the close I noted undercut & rally type moves in the steels I’ve discussed in recent reports, U.S. Steel (X) and Steel Dynamics (STLD). These are also great examples of Ugly Duckling type action, especially X which was selling off on expanding volume as of last Friday while breaking below its 20-day moving average.

X undercut the 33.78 low of December 13th last Friday, but looked for all the world like it was heading for its 50-day moving average. That didn’t happen, and as I blogged yesterday, the undercut simply produced a rally, which when added together produce a U&R move that turns out to be buyable once the stock comes back up through that 33.78 low.

Today X followed through on the U&R by posting a pocket pivot coming off the 20-day line and back up through the 10-day line. Please note how this all occurs after the stock started looking ugly three days ago on the chart. This is a typical U&R move from what we might call a position of ugliness. So the Ugly Duckling gives us a simple trade for simple minds, which, being of a simple mind myself, I quite prefer! By the close, X posted what looks like a trendline breakout, although the pocket pivot is good enough.

 

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Being a cousin stock of X, Steel Dynamics (STLD) acted similarly today, although it did post its pocket pivot volume signature earlier in the day once it cleared the necessary volume. Like X, and as I blogged yesterday, STLD posted a little undercut & rally move after looking less than stellar just three days ago on the chart.

The pocket pivot came as STLD cleared both the 10-day and 20-day moving averages on a strong pocket pivot volume signature that came early in the day. Note also on STLD and X that yesterday’s volume just missed a ten-day pocket pivot by one day. Today, however, was the 11th day since the downside volume spike from December 16th, so today’s volume qualified as higher than any downside volume bar over the prior 10 days.

 

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Keep in mind that X and STLD are expected to report earnings on January 23rd and 24th, respectively.

With X and STLD posting pocket pivots, we also saw coppers and other metals stocks post similar moves on the day. You will see a range of pocket pivots today in names like Freeport McMoRan (FCX), Southern Copper Corp. (SCCO), and Rio Tinto Plc (RIO), for example. I only show a daily chart of RIO, below, which posted a pocket pivot today after pulling back to and hugging its 10-day and 20-day moving averages.

Any of these three stocks could be considered actionable using the 10-day or 20-day moving averages as fairly tight selling guides. Keep in mind that all of these stocks will be announcing earnings some time later in January.

 

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We’ve been watching Square (SQ) on the Gilmo Live Blog over the past few days as it has undercut the 13.65 prior low in the pattern and its 20-day moving average. This put it on U&R Watch, and it finally pulled it off by rallying above the 13.65 low and the 20-day line yesterday and holding, although just barely.

Today SQ improved on that action considerably by posting a nice-looking pocket pivot off of the 20-day line on volume that was not quite average. Optimally, this was buyable yesterday on the basis of the U&R, but the pocket pivot brings it into play as a buy here using the 10-day line at 14.04 or the 20-day line at 13.79 as selling guides. Note that if one bought the stock on the U&R as it pushed and held above the prior 13.65 low, the 20-day line is now above that. For that reason, it offers a reasonable selling guide for anyone seeking to give the stock more room on the downside.

 

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Over in bio-tech land we can see that two days have actually helped to improve the situation, particularly with respect to these big-stock bio-techs. I generally don’t believe the bio-tech group can take on a significant leadership role without at least a few of the so-called generals coming on as well.

Perhaps these stocks were insulted by discussion of bio-techs over the weekend and thus spurned to show their stuff. For example, Gilead Sciences (GILD) posted a big-volume bottom-fishing pocket pivot off of its 50-day moving average today. And this came on the heels of a bottom-fishing pocket pivot (BFPP) from yesterday coming up through the 10-day and 20-day moving averages.

Note that just three days ago this thing looked like garbage as it pushed to a lower low on expanding selling volume. What a difference two days can make! Note, however, that GILD has posted several other BFPPs over the past few months, none of which has worked. Will the fourth time work?

 

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If I had to pick a big-stock bio-tech name that looks the healthiest, it has to be Celgene (CELG), which I discussed over the weekend. At least it’s building something of a long flag formation as it diddles along its 10-day and 20-day moving averages.

Yesterday CELG posted a five-day pocket pivot coming up through both the 10-day and 20-day lines, but that is only one. Remember that I want to see a cluster of five-day pocket pivots develop in lieu of a single ten-day pocket pivot. So notch up one for CELG. But when we compare the strength in CELG to the strength in GILD over the past two days, it’s clear that the Ugly Duckling play in GILD has had more upside juice. The healthier-looking CELG just diddles around the short moving averages!

 

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Clovis Oncology (CLVS), which I discussed in detail over the weekend as a situation for risk-lovers, has also acted in Ugly Duckling fashion so far this week. Over the weekend it was holding nice and tight along its 10-day moving average, but if you think about it that was just too obvious.

So the stock simply decides to scare everyone with a break below the 20-day moving average early in the day yesterday before recovering back well above the 20-day line on heavy supporting volume. That action also qualifies as a supporting pocket pivot at the 20-day line. Today CLVS retests the 20-day line again early in the day, and then bounces its way to another pocket pivot move off of the 20-day line. This time, however, it clears the 10-day line.

I personally find CLVS interesting as day-trading stock, and its moves over the past couple of days have been useful in this regard. Based on its prior track record and dependence on a couple of new drugs going through trials, I am terrified of holding this overnight. However, someone holding a small position, say 5% of total account equity, merely risks losing 5% in total to their account value if something goes haywire on the product news front.

In exchange for that, you could have the potential of a double or triple from here, which would add 5% to 15% to your account value. In any case, CLVS is a high-risk situation, but risk is often commensurate with reward, so take your shots or not, as you see fit, and add salt to taste, as I like to say!

 

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One positive for CLVS is the fact that it trades 1.9 million shares a day on average, which makes it relatively easy to handle, particularly if one is short-term trading it. Myovant Sciences (MYOV) is an entirely different situation, and certainly not one I consider appropriate for rapid-fire trading. The key here is to ignore strength and just wait for a pullback after the stock puts on a show of upside prowess.

Case in point with MYOV is last week’s big-volume move in excess of 14% in one day. Chasing that and buying near those highs would have been painful over the past couple of days. But exercising patience and looking to buy weakness as the stock came into the 10-day and 20-day moving averages this morning would have been the correct procedure to follow.

Buying near or around the confluence of the two short moving averages would have allowed one to ride the stock back into positive territory today as MYOV posted yet another pocket pivot. So the message here is clear: if you’re looking to buy or accumulate MYOV shares, do so on weakness coming into a clear point of reference as a tight selling guide, such as the short moving averages.

 

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One area of the market I would keep an eye on would be Chinese-related stocks. Almost all of these have been soft since the election, thanks to the President-Elect’s anti-China rhetoric. From a practical standpoint, however, it may turn out that his bark is worse than his bite when push comes to shove. Engaging in an all-out trade war with China is not likely to be in the U.S.’ practical interests.

On the other hand, frank discussions may have the potential to improve our relationship with China and in turn could be construed as constructive and positive for both sides. If we think about it, this is certainly not what the crowd likely expects to see, so the crowd is in a position to be faked out. As would be the case with beaten-down bio-techs, the first thing I do is look at the stocks to see what might be percolating. Among these, I note that JD.com (JD) flashed a pocket pivot, albeit a stalling one, at its 10-day moving average yesterday.

There are some other interesting features here on JD’s daily chart as well.  Note, first of all, that while the stock did get whacked after the election, it did manage to regain its 50-day moving average on a bottom-fishing type of gap-up move in mid-November.

More recently, the stock slid back to the lows of the price range it formed between mid-November to mid-December, taking it just below its 50-day moving average. There was never any heavy, sustained selling volume at that point, and the stock recently undercut the lows of that mid-November to mid-December price range. That sets up a possible U&R, and further weight is added to the bull case for JD with the addition of a pair of pocket pivots off the 10-day line yesterday and today. Those stalled a bit, but overall the action looks tight over the past couple of days.

So sitting here along the 50-day moving average the stock becomes buyable using the 10-day line at 25.69 as a tight selling guide. Alternatively, the 200-day moving average provides a much wider selling guide, but it is still only about 5% below where the stock closed today.

 

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I’ve also been watching Momo (MOMO) recently as it has come all the way back to the top of the large price structure and consolidation it built extending back to its original IPO in December 2014. The stock has been hit by the Trump Factor as well news that Alibaba (BABA) has been reducing its active stake in the company.

 

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As I’ve discussed in previous reports, they were likely the sellers into the big gap-up breakout after earnings that reversed hard in early November of last year. When you own somewhere north of 27% of a particular company’s stock, it strikes me as quite responsible and prudent to use a huge price run-up such as we saw from early July into early November to lighten up.

And of course a big breakout after a blow-out earnings report is the perfect opportunity to do so. BABA is certainly an institutional type of investor in MOMO, and this is how institutions with big positions have to act. Does it mean they have some inside info on the longer-term situation at MOMO? Maybe it does, and maybe it doesn’t.

If it doesn’t, then look for the price/volume action to serve as your first clue. So what we see here today is a five-day pocket pivot on a Wyckoffian Retest of the 200-day moving average. Note that MOMO tested the 200-day line in the latter part of December and found near-term support at the line.

Last Friday MOMO dipped back down toward the 200-day line in a Wyckoffian Retest as volume dried up sharply. This set up today’s five-day pocket pivot, which just missed qualifying as a ten-day pocket pivot by one single day. As I blogged earlier today, I think the stock is worth a shot using the 200-day line as your maximum downside selling guide with the 10-day line at 18.56 providing an alternative as a much tighter selling guide.

 

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Weibo (WB) is another formerly leading Chinese internet name that has undercut the 41.26 prior low as it has now put in what could be the second low of a possible double-bottom base that is currently in process. I show the weekly chart below instead of the daily chart, but WB looks similar to MOMO in that it just missed posting a bottom-fishing pocket pivot at its 10-day moving average by one day.

However, with WB moving back above the prior November low at 41.26, it comes into play as an undercut & rally set-up using the 41.26 low as a selling guide. WB closed today at 43.20, which puts it within 5% of that low. In my view that’s reasonable risk, and far better than using 7-8% as a blind stop. My preference here would be to use any pullback toward the 10-day line at 41.76 as a potentially lower-risk entry opportunity, should that occur. Watch for WB and MOMO to perhaps move together as cousin stocks.

 

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Martin Marietta Materials (MLM) is another one of these Trump Rally leaders that started to look ugly last week as it dipped below its 20-day moving average on increased selling volume last Friday. Today MLM regained the 20-day line on a clear pocket pivot off the 20-day line and back up through the 10-day moving average.

In my view this puts MLM in a lower-risk long entry position using the 220 price level or the 50-day moving average at 215.45 as a maximum downside selling guide. Overall this strikes me as percolating type action with many of these stocks that posted pocket pivots today looking like they are revving up for something. What that is we shall soon see.

 

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The same can be said for Delta Airlines (DAL) which also perked up today on a small gap-up pocket pivot move that took the stock back above its 10-day moving average. While the stock has been on POD-Failure Watch I have maintained a two-side view of the stock over the past couple of weeks.

And here we see clearly bullish price/volume action that keeps the stock in play as a long idea. Thus this becomes buyable here using the 20-day line at 49.65 as your tight selling guide. It’s been interesting to watch how these stocks have flashed signs of strength and weakness over the past couple of weeks without resolving clearly in either direction. Now we are seeing the resolution begin to show up as a bullish one, and that includes all of these names such as X, STLD, RIO, MLM, DAL, and others.

 

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On the short side of the market there hasn’t been much that has worked, at least not in terms of substantial price movements. Some notes below:

Amazon.com (AMZN) is mostly tracking sideways as it chops along on either side of its 10-day or 20-day moving averages. With earnings expected at the end of the month, investors may be waiting to see what the company reports before deciding AMZN’s ultimate fate.

Facebook (FB) had a playable downside break going into year-end but over the past two days has pushed back up toward its 200-day moving average. The closer it is to the line, the more optimal your potential short-sale entry opportunity becomes.

Qualcomm (QCOM) continues to flounder below its 50-day, 20-day, and 10-day moving averages and looks to remain shortable on rallies up into the 50-day moving average at 67.28.

Finisar (FNSR) broke to lower lows yesterday after reversing at the 50-day moving average. It held tight today, and still appears shortable on any rallies back up to the 50-day line at 29.57 as more optimal short-sale entries.

Lumentum Holdings (LITE) has moved in tandem with FNSR over the past few days after reversing at its own 50-day moving average yesterday on heavy selling volume. For now, this remains shortable on rallies back up into the 50-day line at 39.12.

Over the weekend I pointed out that “we have to remain cognizant of the fact that many stocks could simply go about the process of building bases as the new Trump Administration begins to sort things out.” So far in the New Year, a number of these stocks have already started to sort things out with a number of pocket pivots showing up all over the place today, particularly among the names I’ve been following in recent reports.

Meanwhile, everybody’s attention appears to have been taken off of Dow 20,000, so with nobody watching the pot any more, perhaps the water can boil. I wouldn’t be surprised to see Dow 20,000 hit in the next couple of days, but we shall see. Ultimately it isn’t that important, if only it weren’t for all these Dow 20,000 coffee mugs I ordered yesterday. ;-p

And so as the Wall Street Journal warns us with “A Laundry List of Reason to be Cautious About Stocks” this morning, stocks just decide to move higher. And I think that if you’ve been watching the stocks first, and everything else second, you’ve been able to pick up on which way to go as we start the New Year. Where the year will end up I don’t know, but we can certainly see how it is beginning, and for now that’s all we need to know.

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 positions in MOMO, RIO, TSLA, and STLD, 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. ©2008-2018 Gil Morales & Company, LLC. All rights reserved.