Analyzing the Market: Two Rare Patterns Forming in Equities

Shine On, You Crazy Diamond
-- Pink Floyd

The past week’s action has been nothing short of stirring, to say the least. But then again, with the EU European Fund Stability Facility news two Thursday’s ago and this past week’s MF Global (MFGLQ-PK) debacle, the markets have begun to show some interesting insight, technically anyhow.

To preface my firm's findings, let me briefly explain the start to our mornings. Every day we have a morning portfolio meeting that requires all  portfolio managers to bring a list of stocks to the table that they believe are opportunities, long or short. We call this our new opportunity list (NOL). This list is ranked, through various metrics, and sorted to ascertain top-ranking opportunities (TROs). Over the last month, this list has vacillated tremendously in ways we’ve never seen. Longs turning into shorts, shorts turning into longs -- rankings vacillate from TROs to not even being considered any longer. On an individual equity basis, it’s an utter madhouse of changing landscape.  In all honesty, confusion is high as we search for clarity.  However, as the week went on something interesting appeared, and not just once – more so, 50% of the time.  

Two patterns, both somewhat rare, are forming in a great deal of equities with no adherence to one particular sector.  The patterns now appearing are like watching nightly clouds dissipate as stars begin to appear in the sky -- they're everywhere. Both of these patterns indicate massive indecision and a potential turning point. By the same token, the first pattern emerging is actually part of the second. Let’s define…

Broadening Top (or BT): (Wedge, Symmetrical Triangle – liken to a Megaphone):  This pattern, because of its infrequency and difficulty to ascertain – higher highs and lower lows – will catch many investors off guard.  Edwards & Magee, Technical Analysis of Stock Trends – one of the best technical pattern books ever written (my firm calls it the “Bible”) – defines it as a market which is lacking intelligent sponsorship. (Erratic seesaw action with a downward sloping 150 or 200 DMA at a longer-term resistance point). Sound familiar?

Here are three examples (of many): Sigma-Aldrich (SIAL), Stericycle (SRCL), and Time Warner Inc. (TWX).


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Others include Hartford Financial Services Group (HIG), CIGNA (CI), Gilead Sciences (GILD), Amgen (AMGN), Kraft Foods (KFT), Procter & Gamble (PG), Colgate-Palmolive (CL), Electronic Arts (ERTS), and Symantec (SYMC).

But the music doesn’t stop there. We’re beginning to see a further pattern develop, one with even more rarity -- a Diamond Top!  

Diamond Top (or DT): The easiest way to explain a DT is by taking a broadening wedge and adding a pennant to the other side. These typically occur at the top of a move and appear mainly in bear markets when a bull rally hits resistance.  



The psychology behind the pattern is relatively simple. It’s a tug-of-war between the want-ins and the want-outs. The first half, as stated, is the BT. The second half is this tug-of-war getting tired -- a waning, if you will. The good news with these particular patterns is that once broken (and retested), the moves are usually large because of the number of investors betting, either one way or the other, who have to switch sides. Otherwise stated: They are massive inflection points. Diamonds mainly occur at tops and are considered bearish. But if they do happen to go topside (20% to 30% probability), it is an indication of change of longer-term trend -- hence the inflection.

Here’s a few to gather what we’re talking about: CA Technologies (CA), Automatic Data Processing (ADP), Cognizant Technology Solutions (CTSH), Check Point Software Technologies (CHKP).


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Others Include Walt Disney Co. (DIS), Johnson & Johnson (JNJ), Teva Pharmaceutical Industries (TEVA), NYSE Euronext (NYX), American Express (AXP), Fiserv (FISV), Intel (INTC), Altera (ALTR), SanDisk (SNDK), General Electric (GE), United Technologies (UTX), 3M (MMM), Tyco International (TYC), Apollo Group (APOL), Intuit (INTU), Oracle (ORCL), Dell (DELL), JPMorgan Chase (JPM), Citigroup (C), Morgan Stanley (MS), FedEx (FDX), Boeing (BA), and FLIR Systems (FLIR).

As Roger Waters wrote it: "You wore out your welcome with random precision… Come on you raver, you seer of vision; come on you painter, you piper, you prisoner, and shine!... We’ll bask in the shadow of yesterday’s triumph. Shine on, you crazy diamond!"

When evaluating the market, investors must occasionally take a step back and see the bigger picture. It’s been a difficult four months, and many of us have been whipped around while attempting to make headway. Frankly, we can’t remember a time when our positions limits (gains or losses) have been hit so fast and the positions have been closed. This is when Albert Einstein’s definition of insanity resonates through every trade: “Keep doing the same thing, expecting a different result.”  

There is no hard and fast rule that states you have to be “in." Sometimes the best choice is remain on the sidelines. This, for many, is difficult due of the inherent emotion of wanting, or the feeling of needing, to be involved. It takes intestinal fortitude to overcome these emotional needs. It is up to you to decide. But remember this: Have a process, a plan, and a deep-seated confidence about your decision. Don’t guess and hope! This isn’t Vegas, even though sometimes it feels like it.

Good luck and stay tuned – I hope this helped!

Editor's Note: Read more at Tuttle Asset Management.

Twitter: @TAM_News

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