AN: Triangle lore

Update 8/15/2013: AN moved below its stop/loss level in early trading, signalling closure of the position. I closed it immediately after the 30-minute waiting period required by my rules, since the position was structured as long shares and so no mitigation was available.

The symbol lost 4.2% during the 13 days the position was open.

In retrospect, a better course of action would have been to abandon my normal exit rules and to get out when it became clear that the triangle breakout was not persisting, perhaps on Aug. 6, at $48.35, thereby reducing the lost to 1.8%.

Autonation Inc. (AN) rose sharply above its 20-day price channel on Thursday, confirming a bull signal given more tentatively the prior day. The stock closed 3.1% over the prior day's close after reaching an all-time high of $49.40.

The AN weekly chart over the last fie years shows a tendency toward sideways corrections ending in a consistent rise to a new plateau.

The last rise ended in October 2012 at $48.56, setting a ceiling on a correction lasting until Thursday's confirmation. The sideways movement's low was $38.31 in December 2012, but the price has remained above 40 ever since.

This is AN's fifth bull signal since the October 2012 peak. Only one of the four completed breakouts was profitable, yielding 3.4% over 14 days. The remaining three had an average loss of 5% over 33 days.

The resulting win/lose yield spread is an abysmal 1.6%.

AN 2-years 2-day bar

AN has traced an ascending triangle in the present correction, a pattern that suggests continuation to the upside once the price breaks decisively above the upper line. The price target, according to the lore, can be expected to be the width of the base above the breakout level. The based is $10.25 wide, the triangle breakout is from $48.56, and so the price target is $59.81.

I don't entirely buy triangle lore -- it just seems to neat by half. Chart patterns, like much in the markets, are Tinker Bell structures. If only enough traders believe, they will come true.

In Elliott wave terms, the correction is a triangle that completed its five-wave run in June -- unless it is extending, which certainly happens in wave counting.

The bottom line is that thee is no way to know for sure that the correction is complete. The best I can do as a trader is to trust that my trading rules will get me out with minimal losses if it turns out that AN is correcting further.

Volume has been high on the breakout and confirmation days, buttressing the case that the breakout is real and not a head fake.

If the correction is over, then the uninspiring historical results from trades won't matter.

Autonation, headquartered in Fort Lauderdale, Florida, sells cars in the United States from 258 new vehicle franchises, mainly in the Sun Belt. It also sells used cars, repair and maintenance services, and financing.

No one buys a car if they believe they might be laid off, so Autonation's success is intimately tied to the economic recovery, which seems to be increasingly shaky. Analysts might well be thinking of that when they rate AN. Their collective opinion comes down to a negative 82% enthusiasm rating.

Even so, the company has been making money. Return on equity is 19%. Debt is equal to equity, a high level in my book.

Earnings have risen in most of the 2 quarters I'm looking at, and all but two -- the most recent being the 3rd quarter of 2012 -- has produced an upside earnings surprise.

Institutions own 63% of shares and the price us cheap. It takes only 35 cents in shares to control a dollar in sales.

AN on average trades 805,000 shares a day, sufficient to support a moderate selection of option strike prices. Open interest, however, runs to the two- and three-figure range, and it might not be possible to structure an option trades with sufficient liquidity to meet my preferences.

Also, the bid/ask spread on front-month at-the-money calls is 9.1%, on the high end.

All in all, if I trade AN, I'll give preference to shares rather than trying to pry a leveraged position out of this options grid.

Implied volatility stands at 19% and has been falling since mid-June. Options are pricing in confidence that 68.2% of trades will fall between $46.57 and $51.95 over the next month, for a potential gain or loss of 5.5%, and between $47.97 and $50.55 over the next week.

Options trading was running hot on Thursday, with calls at nearly four times their five-day average volume and puts at more than double the average.

The fair-price zone on Thursday's 30-minute chart ran from $48.62 to $49.38, encompassing 68.2% of trades surrounding the most-traded price, $49.16. The price opened below the zone and closed near the top.

AN next publishes earnings on Oct. 21.

Decision for my account: The logic of the trade relies solely on the triangle pattern. Has it broken out or not? The chart shows a breakout, and therefore in all honesty there is nothing to stop me from making this trade, except fear of being wrong. Fear, I've found, is a weak basis for trading decisions.

I intend to open a position in AN on Friday if it continues to show momentum, structuring it as long shares.

References

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

At several points in my analysis I use the number 68.2%. 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. StockCharts has a good explainer. The principal practioner 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. 

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.