Tuesday, October 16, 2012

DE: Fool me twice...

An earnings season makes it tough to find trades, at least for traders who, like me, don't open new positions within 30 days of an earnings announcement.

The pre-announcement month is when a the market anticipates what the quarterly report will show. The market may be dead wrong, but that volatile month is when trends happen that can be profitable. If I open my position closer to the announcement, then I miss out on that potential profit.

Some traders also close their positions before the announcement, but that's not my practice. If the markets are right, then I want to harvest the big bucks from any post-earnings gap. If they're wrong, well then, I may lose some money, but through prudent position sizing and stop/loss management, I'll live to trade another day.

Deere & Co. (DE) was the one stock in my pool of liquid issues to both show a Turtle Trading signal and to also be far enough away from earnings for me to play it.

DE began its current uptrend on Aug. 29, ironically on the day of a break below its 20-day low of $73.73, triggering a Turtle bear signal. It then immediately retraced above the breakout point, beginning a rise that today hit a swing high of $84.43.

As the saying goes, Fool me once, shame on you. Fool me twice, shame on me.

The Turtle Trading system is prone to this sort of head fake. I didn't take that bear trade back in August, and spared myself a quick loss as a result. I skipped it because of a stupid error in reading the chart. I had pegged the prior bearish breakout as a failure, which is a filter for 20-day breakouts. In fact, it was a success. Dumb luck.

Even so, I saw the sort of loss I would have endured, and I made some changes in my methods as a result of that skipped trade.

I no longer open positions immediately on breakout, but rather wait half an hour, in case there's a rapid retracement. I'm thinking of lengthening that to an hour. I only trade if I can open the position at a price beyond the breakout point. I also demand that the breakout be in the direction that the relative strength index is moving. In the case of DE, there was a divergence.

Today's break above the 55-day high has this in common with the August failure: Both have moved 0.8% beyond the breakout point. The difference is that the price retraced last August before the day was ended; today the price remains beyond the breakout point.

Also, a break above a 55-day extreme, in theory at least, is a sign greater momentum. On the other hand, both breakouts are happening with lower volume, a sign of flagging momentum.

In my August write-up (you can read it here), I also identified a triangle. I wrote:
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.
The breakout from the triangle happened in mid-September, to the upside, resolving that particularly un-helpful piece of ambiguity.

The upside breakout argues for the large base of the triangle, from $59.92 to $89.70. Triangle lore says the continuation will travel the width of the base -- about $30 in this case -- so the target price would by this method be about $108.

I'm not a Triangle trader. I find them to be sort of messy. But there are those who find them to be useful. The target price would bring DE about 8% above its 20-year high of $99.80, set in April 2011, so it's not an unreasonable goal.

Today's breakout carried the price above a sideways area of congestion from last March and April. The top of the triangle base -- $89.70 -- is the next resistance to the upside.

DE's financials remain unchanged from my August write-up. The broker enthusiasm index for DE remains unchanged, at a miserable 6%.

The stock's average volume is down sharply, now at 2.9 million shares a day compared to more than 5 million in September. Options are trading with open interest running in the three- and four-figures. The front-month at-the-money bid/ask spread is 3%.

Implied volatility stands at 22%, near the bottom of the six-month range. It has been falling in the past week within a longer sideways pattern.

Options are pricing in confidence that 68.2% of trades will fall between $79.11 and $89.61 over the next month, for a potential profit or loss of 6%.

Options are being actively traded today, with volume running 27% above the five-day average. Puts lead at 51% above average, trailed by calls, at 5% below average volume.

The heavy put trading suggests to me that the consensus isn't buying into the breakout and that traders are expecting a pull-back.

Today's fair price range stretches from $83.90 to $84.43, encompassing 68.2% of transactions surrounding the most-traded price, $84.33. The price has made three broad attempts today to establish a most-traded price. This means that the rise is making its way against some headwinds that are slowing its progress.

A bit more than three hours before the close, DE is trading near the most-traded price.

Deere next publishes earnings on Nov. 21. The stock goes ex-dividend in December for a quarterly payout yielding 2.18% annualized.

Decision for my account: I took the trade, a half hour after breakout. I structured the position as January calls with $80 strike prices, for 9x leverage.

I also think it's a position I would take if I were relying entirely on support and resistance, by virtue of the break above last spring's congestion, although I might wait a day to see if it falls back before making the trade.

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.

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