Finding a Trade Candidate 3 Charts

Finding a Trade Candidate 3

Charts

In this chapter we are going to be looking at a lot of charts. When I’m looking for a trade candidate the first thing I look at is the weekly  and then the daily chart of that stock. The chart is my first filter.

As we go through these charts I will proceed with the analysis and will give you the numbers I find to help make a decision about a trade but I may not explain where or how I acquired those figures, all that information is in another chapter.

Let’s start with RRGB, Red Robin Gourmet Burgers Inc. reported this morning;

Red Robin Gourmet beats by $0.16, misses on revs; lowers FY16 guidance  (61.99)

5/17/2016, 8:35:37 AM ET

  • Reports Q1 (Mar) earnings of $1.27 per share, excluding non-recurring items, $0.16 better than the Capital IQ Consensus of $1.11; revenues rose 1.8% year/year to $402.1 mln vs the $415.72 mln Capital IQ Consensus.
  • Using constant currency rates, comparable revenue decreased 2.6% in the first quarter of 2016 compared to the same period a year ago, driven by a 4.1% decrease in guest counts, which was partially offset by a 1.5% increase in average guest check.
  • Co issues in-line guidance for FY16, sees FY16 revs of +8% to $1.36 bln vs. $1.35 bln Capital IQ Consensus Estimate, comprised of flat to slightly negative comparable revenue growth (from low single digit growth), with the remainder due to increased operating weeks associated with locations opened in 2015 and 2016 and acquired restaurants. The Company plans to open ~25 new Red Robins and three Burger Works in 2016. Earnings before interest taxes and depreciation (EBITDA) is expected to range between $150 million and $155 million in 2016 (from $155-165 mln). The sensitivity of the Company’s earnings per diluted share to a 1% change in guest counts for fiscal year 2016 is estimated to be $0.34 on an annualized basis. Additionally, a 10 basis point change in restaurant-level operating profit margin is expected to impact earnings per diluted share by ~$0.09, and a change of approximately $143,000 in pre-tax income or expense is equivalent to approximately $0.01 per diluted share.

Courtesy of Briefing.com

 

RRGB’s growth is negligible at 1.8 percent. Sector (XLY) P/E is 19. 2016 projected earnings are $3.71 and trailing earnings are $3.23. With a 5 to 10 million dollar reduction in next year’s EBITDA (earnings before interest, taxes, depreciation and amortization) I would not expect to see the $3.71 and would use a figure between $3.00 and $3.23 at best. The folks who give us projected figures take a little time to get that information distributed through the system so you must make some adjustment for new guidance. Use your best judgment. If you’re not comfortable with that don’t trade.

Don’t forget that past history (earnings per share and revenue figures) is just that, history. At most I would give it 10 percent weight in my decision because the last couple of years show us the trajectory of sales and earnings. 90 percent of your decision should be based on the projected sales and revenue figures for the next two or three years.

blog rrgb week 5-17-2016

As you can see in the chart above RRGB closed at $50.74, off $10.81 on the day, from a high of $95.00 in August of 2015. The blue line is strong support at $47.45. RRGB will probably get a bounce off the support at $47.45 with a possible target of $55.00 as shown below.blog rrgb week 2-5-17-2016

But, but, but. There are way too many negatives here. First would be the reduced guidance. As a value buyer I want this P/E to be at least half of the sector P/E of 19. That’s 9 ½. $3.00 times 9 ½ is $28.90 so we have a ways to go here.

Next are the circles on the chart. The three circles in the upper center are a head and shoulders pattern, a strong indication of the evident reversal to lower prices. The two circles on the right are a lower high, which indicates lower lows coming.  The third item is the Fibonacci Extension on the chart. Although I don’t believe Fibonacci numbers work on stock charts 50 and 100 percent do work. They also happen not to be Fibonacci numbers but a customized Fib Extension gives me a target of $29.35 at 100 percent. There is good support at $30.37 and strong support at $27.47 on the daily chart from back in October of 2012.

There is a fair chance for a trade if RRGB can drop to support at $47.45 in the first hour of the morning. That would panic the sellers out and produce a nice bounce. If that happens, my stop price would be $46.49 and my target would be a 50 percent retracement from the top of the gap down at $57.12 to the low if it doesn’t penetrate $47.45. That should yield a target around $51.75/52.00.

Don’t let a loser run against you when value is a long way off. I won’t take this trade, but I will add it to my Radar Screen with an alert set in the low 30’s.

Before we go further let’s take a look at the construction of a candlestick.

blog-candlestick_chart_scheme_01-en.svg

Courtesy of Wickipedia.org

Support and resistance levels on a candlestick are the upper and lower shoulders of the real body and the ends of the upper and lower tails. These represent the open, close and the high and low of the day, week or minute time frame you are looking at. The shoulders are the strongest S/R but the lower tail is particularly strong when you are trading a rebound stock that has had a good retracement.

 

Support and Resistance

The next most important consideration after fundamentals is finding support and resistance (S/R) easily on a chart. When you’re looking for S/R you want to start with the daily chart, then the weekly and then the monthly if necessary. As you move up in the length of the candlestick (daily, weekly, monthly) you will find that you can often discern the strength of the S/R level just by the fact that an S/R level you see on a daily chart doesn’t appear on a weekly chart at all. The same applies to the weekly and monthly charts. If you’re using a time frame below the daily I hope you’re day trading.

blog gps daily 5-25-2016

First let’s look at all the other information on this chart. The list of prices with $17.62 at the top are support levels down to $14.66. Second we have three green lines which are a Fibonacci Extension showing values of 0, 50 and 100 percent moves. Notice the support level at $17.24 and the 100 percent move at $17.17. The low was $17.00 at this point. With next year’s guidance of $1.92 in doubt my target here is $19.50 with a stop at $16.99.

Gap is not reaffirming its earnings per share guidance for fiscal year 2016. The company noted that the current consensus earnings per share estimate of $1.92 falls within a reasonable range of potential outcomes, excluding restructuring impacts from its store closure and streamlining measures. However, the company also noted that trends in the apparel retail environment would need to improve from the first quarter of fiscal year 2016 in order to achieve this estimate.

5/19/2016, 4:17:19 PM ET

Courtesy of Briefing.com

Now let’s take a look at support and resistance levels. The $17.24 support level is from 10/18/2011 and had a tail at $17.02. The next level below that was $15.80 from 7/24/2009.Next is $14.66 from 4/21/2009 and finally $9.56 from 3/6/2009. As we all know 2009 was when the DOW Jones bottomed around 6600.

Resistance levels above are the bottom of the gap down at $19.66 when lower guidance was issued on 5/16/2016 and then the yellow line at $21.11 which is tail resistance at the top of the gap. Then you have $24.35, $25.70 and tail resistance again at $27.62. I’m sure you’ve noted that the tail resistance lines are in yellow. That’s because these so often are at a significant reversal in the stock that I like to highlight them.

So how did I come up with all these lines? This is sooo easy. Looking at the GPS daily chart the trend is definitely down. Down candles are red, up candles are green. In a downtrend look for two or more green candles or a week or more of sideways movement with a few green candles mixed in (this is called consolidation), the top of where they reverse and head down again is a resistance level. The premise is this is an area where the stock had buyers. It is thought that they are so happy to get back to even money (no loss) that they sell at this point. They may have been sitting on this position for a few months or many years. The next area is the gaps. Both sides of a gap are support and/or resistance. In particular the other side of the gap (on this GPS daily chart $21.11 and $27.62) is strong resistance. The only area of the chart you are interested in is the line of candles NEAREST to your current price.

GPS has dropped to 52 week lows (actually 4 year lows) and support is years back on the chart but resistance is only the first line of candles you see to the left on the chart. All the chain of candlesticks behind that first row to the left are meaningless.

blog gps week 5-25-2016

In the weekly chart above notice that there are many fewer resistance lines. Even the tail resistance is different because GPS had just set new lows two days before it gapped down. The only time a candlestick chart will show a gap down is if the gap appears on a Monday.

The box on the final bars on the weekly chart is what appears on the whole daily chart.

blog gps month 5-25-2016

And finally we have the monthly where you can see the support levels from 2011. Here we find even fewer support levels. The weekly and month S/R levels are progressively stronger and it is easy to see why.

I have seen it written many times that the more hits you have on an S/R level the stronger that makes the level. That is wrong. The second hit on a support level will usually get a strong retracement but from there on the S/R level gets weaker and weaker. The reason is that they are eating through the buyers/sellers at those levels. Every time the level is hit there are fewer and fewer buyers/sellers until they’re all gone and the stock breaks through to new highs or lows. Twice is the charm for me, after that I won’t touch it.

When a stock continues on down through what I consider to be strong support there are two very good reversal signals that I rely on. They are a gap down after a run of three or more candles and a chart pattern called a cup and handle.

WPG

WP Glimcher,Inc. is a REIT (real estate investment trust) invested in retail malls with customers like WalMart, Stages and grocery stores on down to Mom and Pop stores of various descriptions. These are not the Galleria’s of the world. Because of the slow to no growth economy WPG’s cash flow is in doubt.

I explain all this because their trailing earnings are $1.83 and projections for the next three years are similar. The P/E at $7.50 was 4.1. This is unusual with no screaming bad news.

blog wpg daily 2-11-2016

WPG had been falling ever since it IPO’d back in May of 2014. I traded it twice and broke even on the combined trades. If you look at the weekly chart you will see a relentless march down from the $21.00 area with no recovery. There were a few areas of consolidation but that was it until we finally got this Cup and Handle formation.

On the daily chart above this would be a hard pattern to spot. What the pattern is is a new low followed by a bounce and then a retracement that sets a higher low. The buy on this is when the price breaks the bounce high, in this case $8.02.

blog wpg 60 min 2-11-2016

The 120 minute chart above gives us a much better look at the pattern. When I spot this pattern my entry is a stop market order one penny over the cup and Handle high. I don’t do GTC (good till canceled) orders here because if it receives some news and gets a big gap up I don’t want to buy it at 10 bucks. I enter a new order every morning until I get filled or the pattern fails. If it fails I get to buy it cheaper in the future. Although WPG went straight up from here I have had a few break through and then come back down. If that happens the stop price is the low of the pattern. I have only been stopped out once on this pattern in the last couple of years.

Often the daily chart will look more like the 120 minute chart above. In this case the cup and handle on the daily chart was very tight. I find that if they spread out over three or four weeks or more the breakout and the subsequent move are even stronger.

As always, you are responsible for your own analysis. Is it a value trap? Do the projected earnings look reasonable? The analysts that projected those earnings could be just as wrong as you are. Is the stock cheap enough that the rest of the market precipitants will see the value also? If they don’t who will buy the stock behind you? Is your position properly sized? If it continues lower will you be stopped out or will you say, Thank you Lord, I get to by more at a better price? Whatever the problem is with the stock, is it fully priced in now? The sector P/E for REIT’s is 30, at 4.1 P/E for WPG, what do you think? The apparent reason for this extreme valuation is the future lack of small businesses to fill their strip malls.

PRGO

Valeant Pharma confirms Joseph Papa as Chairman & CEO, effective in early May  (35.98)

4/25/2016, 8:38:23 AM ET

Papa joins from Perrigo Company (PRGO) where he served as Chairman and Chief Executive Officer. Papa, who will also join Valeant’s Board of Directors, will succeed J. Michael Pearson, who is expected to remain as CEO and a director until Mr. Papa arrives at Valeant.

Courtesy of Briefing.com

Now let’s take a look at a gap down after a run down. If you haven’t noticed before bad news once again gives us an excellent opportunity.

blog prgo daily 2-24-2016

I guess there may be some people out there who don’t use candlestick charts but I would find it hard to believe because this chart style offers so much more information.

In the daily chart above the lowest candle is green because it gapped down $2.42 from the prior day close of $89.04. The large red candle before the bottom indicated panic which is what I want to see. The gap confirms almost beyond a doubt that PRGO will reverse here. The green candle is because PRGO closed higher than the open on the day.

There are two imperatives that I require to consider whether it is a real for me. Number one that the gap open must be lower than the previous day’s low of the day, the farther away the better. Number two is that there be no fresh news that day. If there is news it must be unequivocally positive.

This is not a value play, but a chart pattern play. XPH, the pharmaceuticals ETF is at a P/E of 17. At $85.00 PRGO’s P/E is 10.1. There is some value here but I have recently bought two pharmaceutical companies at P/E’s under 3.

PRGO is down from $215.00 last year with all the other pharma names. PRGO seems to be one of the better pharma names. What made this a trade was the departure of their CEO and the subsequent $45.00 dollar drop of their stock in three weeks.

blog prgo 60 min 5-24-2016

 

Above we have the 60 minute chart of the bottom in PRGO. The prior day had closed at $89.04 and on 5/13/2016 PRGO opened at $86.62 (#1 on the chart), a $2.42 gap down. PRGO bottomed at $84.85 (2 on chart) and three is a higher low, which gave us a bonus of a Cup and Handle formation.

There are many little refinements to these techniques that I will cover in the future. For now this should give in a fairly advanced idea of what a value trade is and how to trade them.

The part we haven’t covered yet is the psychology involved in trading. This is at least as important as know how to find and then execute a profitable trade. Don’t skip the psychology section of this little treatise.

 

Dave Cappaert

themarketistalkingtoyou.com

davidcappaert@gmail.com

 

 

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