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I thought I would use this week’s article to respond to a reader (thanks, Cam for your message and feedback) as I think his query has wider appeal.
Hi Tom…. I eagerly await your articles in the weekly Trading Tutors newsletter. Reading this week’s article, I can't help but wonder what you're looking for in regards to a breakout into wave 5 of your chosen stocks. WESFARMERS has caught my eye as it is sitting on what appears to be some good support at $34, which also provided some strong resistance in early 2011. Do you look for the oscillator to come back and start to move above zero? What other indicators do you look at? In regards to WES, what will you consider a breakout? I'm interested in your thoughts and I will not take any comments you make as trading advice…”
Let’s start with a look at the WES chart:
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As I write (Wednesday, 10pm AEST) WES has not yet broken out but is showing signs that it might. As Cam pointed out, it has strong support around $34, only minor resistance at $35 and has been locked in this band for almost two months. We also note that the oscillator has held quite well at zero, which is an absolute must. It did go further below zero than I prefer but this does not mean it will not go to Wave Five. It does mean that buyers and sellers are still undecided and so we may see volatility along the way. I have therefore modified the Elliott extension expectation. Usually in cases such as this I would hold out for the second or third Wave Five, but these are not high probabilities here.
Prompted by Cam’s comment about “strong resistance in 2011”, I used my daily chart with the same lines of resistance and support and clicked on the weekly version. This is what I saw:
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I found this perspective illuminating: the same band has actually been providing support and resistance going back to 2005. Quite often we find that resistance equals support. Markets have memories! Whether this ‘memory’ is mathematical or empathic is the subject of some debate.
While I acknowledge the lurking Wave Four, the three Wave Fives suggest some upside for WES on a ‘weekly’ basis over the next two to four years, albeit with a threat of pullbacks. To buy at current levels would be buying up the risk curve a little and getting on board earlier in 2012 would have been better. Nevertheless I am considering the stock as a medium term trade, rather than a long-term ‘buy and hold’, although we do not need to make a final decision on that right now.
Back to Cam’s question – ‘what would I consider a breakout?’ I prefer to buy when Wave Fives first appear and without checking I can say that probably happened on WES a couple of weeks ago. I do not hold WES as you can’t buy every Wave Five that comes along and I try to limit the number of stocks I hold at any one time. I do however hold CPU and will use that as an example to further develop this point later in this article.
I know many traders buy the breakout and on WES this could be at the $35 ‘breakthrough’. Typically I would aim to buy at the low rather than at the current point. I am prepared to make the call and buy earlier and if I get it wrong, I will flick it. It’s very much a personal preference.
Another breakout criterion I use is On Balance Volume:
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In this case OBV is not powerful but this is not enough to hold me back. Then again it may be a reason why I don’t hang on for the second and third Wave Fives.
I also look to Bollinger:
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I like to see parallel lines moving horizontally and then a breakout above the upper band.
(There are other breakout indicators you can use but I like to keep my approach simple. I do not regard myself as a technical purist but I do know how to use simple analysis to make money.)
Finally, to CPU:
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I bought CPU a couple of weeks ago and it went into the money before it started to slide. I did consider selling but held on as I was expecting a breakout from the resistance around $8.60. As you can see, there have been three lows (marked 1, 2 & 3) where you could have bought CPU. Patience would have been required each time as it is never nice to buy one day and see a slide the next. But this can happen and it happened to me on this occasion. The oscillator is lower than ideal but I do not expect I will hold on for the last dollar. The leverage is good on such a move and it is a reasonably easy with manageable risk.
I am strict on some criteria but once I am comfortable about the market overall (as I currently am in the short-term) I am not scared to get into the market when I find trades I like. As I wrote in my book Fair Share, there are no flashing green lights when it is time to buy. You just have to put all you have learnt and practiced into action.
Next week – unless the state of the market demands otherwise - I might write about ‘getting in’, as this is not always easy.
I hope this helps, Cam and thanks for your interest!
Enjoy the ride
Tom Scollon
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