Tim Bovee, Private Trader: XLV: A significant correction

Sunday, May 25, 2014

XLV: A significant correction

The chart of the health-care fund XLV shows the virtue of detailed analysis in trying to diagnose a symbol's condition. What appears to be a mere chronic cough upon further investigation looks more like a case of pneumonia, treatable, to be sure, but requiring more than a bowl of chicken noodle soup.

The price in March began a downward move that will correct a portion of the rise from 2011 to this year. XLV doubled in value over that period, and even a shallow correction will be significant in its magnitude and in the span of time it takes to complete its work.

The Chart

Elliott wave analysis of the three-year chart shows that the rise from $29.64 beginning Aug. 9, 2011 had completed five clear waves by the time it reached the most recent peak, $60.50 on March 6. I've labeled that rise as wave 3 {+2}.

To be sure, XLV has shown certain sameness in the magnitude of its downturns from prevailing uptrend.

But the subwaves within wave 3 {+2} mark out a clear completion, unless wave 5 {+1} is extending, as waves in that position sometimes do. That would lead XLV to rather quickly move above the $60.50 peak and a perhaps substantial further rise. But until that happens, my presumption comes down on the side of caution and a more substantial move to the downside.

Click on chart to enlarge.

XLV 3 years daily bars (left), 90 days 4-hour bars (right)

Wave 1 {+2} took about a 10 months to complete and the 2nd wave correction at that degree, a simple zig-zag, was over in three months.

Corrective waves tend to alternate patterns, so the zig-zag of the 2nd wave implies that the present 4th wave will be a flat, the sort of pattern that makes for a shallow correction but one that consumes more time. It's possible that the 4th wave will be complete this year, but it wouldn't be surprising if it extended into 2015.

Corrections have a tendency -- but not a certainty -- of reversing from one of the Fibonacci retracement levels. A shallow correction to the 38.2% level would bring the price down to $48.71. The deeper 50% level would bring it down to $45.07 and a deep correction would reach the 61.8% level at $41.43.

At this point, I know all I need to know to make a decision about trading XLV and can end the analysis.

Decsion for My Account

The break above the 20-day price channel on Thursday is clearly an upside correction within a larger downward move. Despite appearances at first glance, XLV has a bearish chart, and I tend to steer away from contrarian plays. The downside risk outweights the upside reward by a significant amount.

I don't intend to open a bull position in XLV.

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.