THE ASCENDING
TRIANGLE AS A REVERSAL PATTERN
For the last several weeks I have used this section of
the newsletter to focus on major reversal patterns. The reason for this
concentration is that the S&P 500 has created a major reversal
triple-bottom formation. When the S&P 500, which is a proxy for the
overall market, reverses, many individual stocks also tend to
demonstrate reversal patterns of their own.
Last week I focused on the inverted head and shoulders
pattern, which is common to quite a few charts in this time frame and
which characterized the chart of Gap Inc. (GPS, $17.38). Swing traders
who recognize this pattern in charts they themselves examine will be
able to spot many profitable trading opportunities.
To review: the significance of a reversal pattern can
be judged by three factors. These are the amount of time the stock takes
to reverse, the height or point range of the pattern during construction
of the reversal, and the volume or number of shares that changed hands
while the pattern was forming.
The reversal pattern I want to focus on this week is
the ascending triangle. When traders in my stock market seminars
recognize this pattern, they typically associate it as a continuation
pattern. That is, they see the ascending triangle as a relatively
short-term formation during which a stock enters a period of price
consolidation.
Indeed, the ascending triangle very often plays this
function. However, on occasion, it marks a major reversal in a stock,
and when it does, it provides a very low-risk, high-reward entry
opportunity.
The ascending triangle is marked by two significant
technical features. At its top, there is a line of resistance. This is a
supply line, or a price at which sellers step into the market and unload
their shares. The second aspect of the ascending triangle is the rising
trendline. This line communicates the fact that bullish investors are
over time willing to pay higher and higher prices.
Eventually the bulls or bears must triumph. The
ascending triangle is said to have a "bullish bias" -- so one
should generally expect the eventual breakout to be to the long side.
The more times the stocks tests its upper resistance line, the more
likely it will eventually break out to the upside (because the supply
held by sellers is consumed over time). If a stock tests resistance in
an ascending triangle three or four times, then it is likely that on the
fifth try the breakout will be successful.
When the breakout comes, it should be accompanied by
much stronger-than-normal volume. The higher above normal the volume,
the more power the breakout has and the trustworthier it is.
The measuring principle, which I've discussed several
times in recent issues, can be applied to the ascending triangle. To do
so, take the height from the bottom of the triangle formation. Add that
number to the breakout level and you have the eventual target.
InVision (INVN, $24.31) -- a maker of bomb detection
devices for airport screening -- is an issue we identified in our "Stocks
to Watch" section above. After the terrorist attack on
September 11th, the shares had a tremendous run, surging from near $5 in
September 2001 to a high just below $50 in February 2002 -- a scant six
months later. From there INVN went into a sharp decline, bottoming below
$20.
From a fundamental perspective the stock is extremely
interesting. The stock's PE (price/earnings) ratio currently sits at 8,
and analysts are calling for the firm to earn a whopping $3.43 per share
this year. Perhaps the stock is so cheap because earnings are projected
to decline to $1.97 in 2004. Still, assuming these estimates are
correct, the shares are still be selling at about 12 times 2004 forward
earnings.
As of the last reported figures I could find, 31% of
the 14.1 million-share float
of the stock is held short, leaving the shares primed for a potential short
squeeze. The strategy here would be to buy on a high-volume breakout
of the ascending triangle at $25. So far the stock has tested this level
twice. Note that the average daily volume over the last several months
has been very tepid.
The highly compressed Bollinger bands show that the
stock is in a narrow trading range and predict that a volatile move is
ahead. As long as INVN remains in a narrow trading range between $22 and
$25, the shorts will have no incentive to cover. Above $25, however, I
think they will be fearful enough to be spurred into action.
Note that the shares are now testing their 150-day
moving average for the first time in several months. The average is
still sloping down, but in a strong market the stock could certainly
trade above it. I will continue to monitor INVN carefully for a
breakout.