DE: Turtle and triangles

Deere & Co. (DE) popped below its 20-day low near the close of trading on Tuesday, triggering a Turtle Trading bear signal. I didn't take the trade, however, because of an exception built into at least one version of the rules designed to improve success by filtering signals.

The Turtle Trading system (you can read my version of the rules here) is often presented as an example of simplicity itself: The signals are unambiguous, and they must be taken when presented. But then, the tweaking begins. There are filters. There are exceptions. Things are never as simple as they seem.

By the rules I'm following, the filter applies to a 20-day breakout. If the prior breakout was a success, the rules say, then the trade should be skipped.  If it was a failure, then the trade can be taken.

Failure is defined by how the prior trade was exited. If it was because the stop/loss point was hit -- the s/l is defined as double the 20-day average true range from the entry point (or the day's close if the trade wasn't taken) -- then the trade was a failure. If the exit was because the  price crossed the 10-day price extremity in the opposite direction of the trade, then the trade was a success.

There is no filter on the 55-day breakout.

Confusing? Yes. Here's how it worked with DE.

DE's price moved above the 20-day high of $79.69 on Aug. 8 and closed that day at $79.17 with an average true range of $1.82. So the stop/loss was set at above $75.53.

On Aug. 15, after earnings, the price gapped down, opening at $76.11 and then dropping through the 10-day low of $75.75.

Was the trade a success or a failure? The answer is (drumroll): A success (although one that lost money). The 10-day low had risen to a level above the stop/loss. Although both the stop/loss and the 10-day low were taken out, the 10-day low was hit first. So the trade was a success, and todays break  below the 10-day low (now at $73.73) couldn't be taken.

The DE scenario raises the question of how success should be fined. Intuitively, I define success by whether I made money. The trade from Aug. 8 lost $3.42. On the other hand, coaches I've studied under unanimously teach that a trade is judged not by whether it made money or not, but rather whether the trader followed his or her trading plan.

That latter criterion is what I've used in judging the DE trade.

But none of this is magic. There are no rules handed down on graven tablets. Each trader gets to make up the rules for himself or heself. And that is a rule that I will surely revisit in the future.

Turtle alumni will tell you that the rules mustn't tampered with. To which I say, "Balderdash!" Many rules are meant to be broken, and all are meant to be improved.

DE's price has been trading a symmetrical triangle since July (or since February by another measure, or possibly since October 2011). This is a continuation pattern. The nearer-term view would see it as a continuation of a downtrend that began in April 2011. The broader view would see it as continuing an uptrend that began in 2009.

It's ambiguities such as these that lead traders to rigid rule-based systems such as Turtle Trading.

Looking at the fundamentals only, my vote is for a continuing uptrend over time.

Deere & Co., of Moline, Illinois, is the world's leading maker of agricultural machinery: Tractors, combine harvesters, cotton harvesters, bailers, planters/seeders, sprayer and utility task vehicles.

They also have a large chunk of the construction and forestry equipment business, and they make diesel engines and drivetrains for heavy equipment. Plus, lawnmowers and snowthrowers. Oh, and they'll lend you the money to buy this stuff.

So Deere is big enough to exercise great control over its marketplace. It's also big enough to be an established presence, one with few surprises. Perhaps that's why analysts only give it a 6% enthusiasm rating, the same as a month ago. (I score enthusiasm by crediting strong buy recommendations, subtracting holds and worse, and ignore simple buys.)

The company has huge return on equity, 43% in the most quarter, and large debt to along with it, at nearly triple equity.

The recession hammered annual earnings, pressing them down in 2009 to less than half of the prior year's. Earnings have since rebounded, more than doubling in 2010 and gaining another 50%+ in 2011.

The 2nd quarter, reported in May, is the big earner for Deere, as the industries that use its equipment gear up for the higher pace of spring and summer work. The last two 2nd quarters have had earnings higher than their counterparts a year earlier.

Eleven of the last 12 quarters has shown upside earnings surprises, and only one -- the most recent -- has surprised to the downside.

Institutions own 67% of shares, and it takes only 84 cents in shares to control a dollar in sales.

DE on average trades 5.2 million shares a day, enough to support a wide selection of option strike prices with high open interest and narrow bid/ask spreads. The bid and ask for the front-month at-the-money calls are only 1.4% apart.

Implied volatility stands at 25%, a bit above the six-month low of 20% on Aug. 17. Options are pricing in confidence that 68.2% of trads will fall between $69.03 and $79.71 over the next month, for a maximum gain or loss of 7%.

Options are trading at 88% of their five-day average volume, with calls having the edge, at 126% compared to 66% for puts.

Today's fair-price zone runs from $73.48 to $74.09 and encompasses 68.2% of transactions surrounding the most traded price, $73.61. At this writing the price is at $74.37, slightly above the zone.

Deere next publishes earnings on Nov. 21. The stock goes ex-dividend in September for a quarterly paying yielding 2.47% annualized.

Decision for my account: I had pegged DE as a potential Turtle Trade, and so I'll go by the Turtle rules, which means no trade this time. If the price should break below the 55-day low, the filter wouldn't apply, and I would open a bear position. The 55-day low is presently at $72.38.

The triangle at present is at about $79.30 on the top and $73.14 at the bottom, and they'll continue to narrow pending a breakout. 

A break beyond the triangle boundaries would be tradeable, but the question of price target depends upon when the triangle began. That will be determined by the direction of the breakout. 

If it's to the upside, then the triangle began in October 2011 and the target is $40.28 from the breakout point; if to the downside, then the beginning was June 2012 and the target is $20.19 away. Either way, it's a significant distance.

In the very near term, the most recent lowest low was $72.85, and a break below that level would suggest a push down to the next support level, $69.51.

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 decision decisions for his or her own account, and take responsibility for the consequences.