Tim Walker
Tim Walker

This old motto of the Boy Scouts and Girl Guides could well be applied to the stock and commodity markets. In particular, we should be constantly on the lookout for good set ups that suit our individual trading styles. And then we should ‘be prepared’ for them to go either way.

A great illustration of this is playing out on Verizon Communications (VZ:NYSE). A couple of alert traders - one from my Cotton Webinar forum and the other from my Advanced Trader Coaching forum - spotted this set up.

Chart 1 – Verizon Double Top

click chart to enlarge

What you see here is probably my favourite set up – a double top on a major 50% retracement level. Why do I say a major retracement level? If you look at this monthly chart, you can see that it covers more than a decade of prices and marks the range between the high and the low of this entire period. Indeed, the 1999 high is the highest high for the whole period for which data is available for this stock, which is from 1990 to the present. It may or may not be its All-Time-High price, but it is certainly a very major high.

A little work with a calculator will also reveal that all these prices are related. The 2008 low is 25% of the 1999 high, and twice that low gives the two current high prices. There are also some repeating ranges in there if you care to dig a little bit.

Once you have all this information together, your analysis is complete. The only thing left to do now is trade it. For this we need trading rules, including signals to get into the market and a plan to manage the trade.

Let’s take a look at the daily chart.

Chart 2 – Looking for an Entry

click chart to enlarge

If you look carefully at this chart, something should stand out. This stock has had a solid run up since its low on 10 April, which made a false break of the previous low on 30 January. These two lows were 71 days apart.

During May, when many stocks surrendered a good proportion of their gains for the entire year, Verizon went higher, making consistently higher swing bottoms. This was a sign of strength.

On the day of the double top (13 June) volume was low, and the market sold off from its intra-day high. However it did not give a strong reversal signal, closing above the previous day’s close and above the open. Therefore its temperature reading was +4. So the signals were mixed.

Nevertheless, trading rules come to the rescue here. Depending on your own Trading Plan, you might place an order to go short on the breaking of the low of the top day. Or you might wait for the first lower swing top, a safer place to enter and one that involves much less stress.

But as I said at the beginning, you should always be prepared for the other eventuality – that the market goes higher. Interestingly, this is exactly what happened earlier this year on another communications stock, AT&T (T:NYSE):

Chart 3 – AT&T Set Up

click chart to enlarge

In the AT&T case, after a reaction the market broke through the double top and pushed higher. This is a sign of strength and you could go long. As you can see, T has continued to advance since the breakout on 26 April. This illustrates perfectly what Gann says about watching the trend of each individual stock, as it may go completely contrary to the trend of the general market. T has offered two profitable ABC long trades since then and has broken only 1 swing bottom, and that by only 3 cents.

But what about Verizon? Let’s have a look.

Chart 4 – What Happened in VZ

click chart to enlarge

Well, Verizon didn’t bother with the retracement from the double top as AT&T did, but instead broke straight through. While there was an ABC long trade only a couple of days earlier, you would likely not have taken this trade, as the 50% milestone was beyond the old top level. But you could have gone long on 14 June, the day of the breakout.

You would need to work out how much of a breakout you would want to see so as to guard against the possibility of a false break and reversal. You might use 10 cents, or perhaps 1/3 Average Range, which for stock would be 17 cents.

In any case, this stock is currently in a strong position and higher prices are expected.

Certainly the Communications Sector appears to be doing well.

Knowledge is Power!

Tim Walker