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The Morning Cup of Jo

By

Gotta "Read the Lines!"

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There's a statement I'd like to make to preface this mornings 'Jo.'

'Last night, after proof reading this article, I came to the realization that many investors who did, or still do, own Nokia (NOK: NYSE) may take this article with some discontent. I would like to say, in all humbleness, this article was written merely to show the importance of 'Readin' the Lines' when trading stocks - not to mock anyone who was involved with yesterday's debacle. Trust me, we've ALL been there before!'

Trademark Pending

Yesterday William Fleckenstein (Professor Fleck) stated, on Buzz and Banter, "The Island Reversal on Nokia (NOK: NYSE) is as big as Maui." I'd like to up the stakes and say it's the size of Greenland (the world's largest island). Whatever the case, I felt today would be a good opportunity to point out a few technical issues associated with Nokia and its subsequent Island Reversal.

But before we begin, it's important to understand just what we're talkin' about. Island Reversals are particularly uncommon and therefore rarely discussed. However, Toddo brought it up a couple of days ago with General Electric (GE: NYSE) and obviously again yesterday when Fleck Buzzed about Nokia. This is like wanting to buy a nice car, thinking no one else has one. Once you make the leap and purchase, you see it everywhere. Go figure!

Anyhow, an Island Reversal is, for lack of better words, isolated price action. An island occurs in three simple steps. First, it starts with a gap (up or down) on relatively high volume (mainly news driven). This is followed by intermediate price action where the security trades with no substantial movement. Then, POW! - another gap in the opposite direction (also, for the most part, driven by news), leaving a proverbial Hole where the security never traded - thus, creating an island. Nominally, islands are formed in less than a week or two. In technical terms, islands are used by teckies as 'road signs' to possible changing trends - not unlike large volume reversal days. After most islands occur they tend to be part of a larger and more significant technical pattern, which we'll revisit in the next example.

First let's take a look at a normal island reversal with GE. First notice how once GE broke its 200DMA the next day it bestowed a gap down. This was followed by 4-days of non-movement in price. On the 5th day, my true love gave to me, 5 - golden - rings and GE gapped up above the 200DMA, skipping back over the $30 price level, hence leaving a hole in the price action. Before we move on to Nokia you should give GE one last examination. Observe how the island is actually the Head in a small inverted Head & Shoulders formation.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

On to Nokia and the main point of this 'Jo' - "How to avoid getting caught in this situation." Many times investors (institutions and individuals alike) like to buy off of good earnings news, just like aggressive techies like to play off of gaps. That's all fine, if you're willing to listen when the particular equity's tellin' you it could be time to go. Yeah, I know - hindsight's 20/20; indulge me for just one second.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

After Nokia announced a banner 4th quarter, back in early January, the stock gapped higher and closed at the higher end of the day's action. Good technical sign. Over the succeeding 2-months the stock went onto make 2 separate relative highs. Another good sign, or was it? Take a look at the momentum indicators and the volume. The following 2 relative highs not only showed volume divergence (lighter volume as the stock was going higher), it also had all three-momentum indicators (MACD, RSI, and Stochastic) showing divergence as well. Road signs? Possible accident in the road ahead? Look out below?

Okay, let's say some investors don't watch momentum, only price and volume. Granted, the decreasing volume on higher relative prices is not enough to sell a stock, I agree. However, take a look at when Nokia broke its 50DMA. Over the following 10-days the distribution volume increased substantially.

Allright, I agree; still not enough to sell the security. How about this? The following 8-sessions brought an increase in price and decrease in volume ALMOST EVERY SINGLE DAY, until it finally tested the bottom-side of the 50DMA and couldn't make it through. Enough evidence to sell yet? Then POW, right in the kisser! Another earnings related announcement and voila - The largest Island Reversal I've ever seen, really!

Now, if Island Reversals are predominantly a smaller portion of a larger technical pattern, then - well, you get the picture. This is why I have the weekly chart posted below - "Where's the next relative support if Nokia breaks further?" You may also want to take note of the MACD and RSI on the weekly graph and see how they already broke down prior to yesterday's catastrophe.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

Look at it this way -- many people don't believe (understand) the theories behind Technical Analysis and that's okay. However, answer this my friends. "If you watched Nokia develop technically over the last quarter, knowing then what you do now, do you think some investors would have chosen something different to do?" How about this question... "Do you think that the fast, short-term money was too involved emotionally, about the prior quarter's earnings announcement, to not see the forest through the trees?" Just questions, not opinion.

I Hope this 'Jo' Helped !!!

Until next time...

The KAT

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No positions in stocks mentioned.

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