David Dixon In my previous article (see Trading Tutors Issue #142), I introduced the idea of comparing a stock chart to its sector as this can be a very useful method for finding directional trades. What I’m looking for are stocks trending with their sector. When forming my opinion as to where a particular stock is heading in the future, it is vital to have the stock and its sector trending in sympathy.
This article is going to take a closer look at the Health Care Sector (XHJ). This sector has been trending strongly since the start of its bullish run in March 2003. However, over the last 6 months the XHJ index level has found some resistance at around 6500 and this is where the index resides today. Chart 1 below provides a snapshot of where the index has been trading over the last year.
Chart 1 – Health Care Sector
click chart for more detail
The first of the blue highlighted circles emphasises April-May 05 and shows where the sector found support at 4583. This formed a classic ‘M’ double bottom pattern, after which the market resumed the overall upwards trend.
Also on this chart, I have drawn blue arrow lines. These lines mark the rallies and retracements since the double bottom. As you can see the rallies in the upward direction have clearly been reducing, while the retracements have been expanding in the downwards direction.
I have used a yellow highlighted circle to show where the sector pulled back below the 50% highlighted line. The sector found support at 62.5% of the previous August 05 to September 05 range. This was an important retracement as it was the largest pullback since the start of the bull campaign in March 03. From the October 05 low the advances started contracting and the pullbacks started expanding - all signs of loss in momentum.
The second of the blue highlighted circles is showing a potential double top at 6500. This double top is once again adding to the overall view that the sector is setting up for some downside.
Taking this view, I now want to find stocks that trade within this sector. One stock that stands out is Cochlear limited (COH). This stock has been having a great run, but as Chart 2 below indicates, a pullback is due.
Chart 1 – Cochlear Limited Daily Bar
click chart for more detail
Looking at the above chart you will see that I have applied the ABC pressure point tool to measure the May 05 to August 05 range (noted A – B). I have then applied this A – B range to point C (October low). In doing this I am comparing the current range to the previous range and looking for repeating ranges. As you can see, history repeats in price. Over the next few weeks I expect COH to retrace towards $42.25, which is the 50% retracement level. This analysis provides sufficient warning for me to cover all my long positions in this stock.
To be a more complete trader it is important to look at all information made available to you by the sector charts. It is a simple way whereby you can form a view about the direction the stock under investigation is likely to head. The use of simple technical indicators such as double bottoms, double tops and repeating ranges provides a platform for increasing the probability of success in your favour.
Keeping the dream alive
David Dixon