CapitalSource Inc. (CSE) broke above its 20-day price channel on Wednesday, sending a bull signal according to the Turtle Trading method that forms the basis of my rules.
Turtles who follow the pure doctrine would jump in upon the signal, a price broke above $11.88.
That break, however, leaves the price below the near-term swing high of $12.36 on Aug. 1. Arguably, the true breakout on the chart, rather than according to doctrine, lay 48 cents away when the Turtle breakout occurred.
The discussion pits Turtles against a legendary trader called Joe Ross, who put great store on breakouts based on chart pricing rather than arbitrary rules. Joe would ask, What's special about the 20-day high? Why not 19? Or 23?
Joe's method lets the price peaks define the breakout level. While the Turtles survey the field broadly from the air, Joe is always always down in the brush, boots on the ground, seeing what the field looks like up close.
I did a little study in 2011 that pitted Turtle Trading against Ross' method. You can read it at "Smackdown: Joe Ross vs. the Turtles". In it, I summarize the Ross method as "Turtle trading plus wait-a-sec", and any who read my trading rules, with their deliberate slowing of the process, will see his influence.
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| CSE 3 years 2-day bars |
The $12.36 peak on the CSE chart takes on great significance in my analysis because I see it as the end of an uptrend that began from $5.96 on June 5, 2012. That's a major move, and if my analysis is accepted as correct, it would be unusual to say the least for the price to again top the $12.36 level.
The uptrend, according to the Elliott wave count, has completed five waves, three up separated by two down.
The correction that has just begun is of the same magnitude as the rise of the past 15 months. Typically, it would correct down by one of these distances:
- 38.2%, to $9.92
- 50%, to $9.16
- 61.8%, to $8.40
Those aren't guaranteed levels, only of higher probability. A correction would stop short of $5.96, but it could end up anywhere above that but below the $12.36 peak.
There is no also no guarantee that the time span of a correction will be similar to that of the trend being corrected. A correction can happen quickly, or it can dawdle.
CSE was one of four symbols that survived my initial screening last night, all having broken out to the upside. All confirmed their breakouts by continuing to trade beyond their 20-day price channels.
One, ZONMY, is too illiquid for my preferences.
CSE has the highest average volume of the three remaining picks, and it is also the only one to score a bullish ranking from Zacks.
RGA received a bearish ranking from Zacks, and I prefer that my trades and Zacks, where possible, be aligned.
The remaining symbol, PKY, looks fine at first glance, but based on the higher liquidity, I decided to give a more detailed look at CSE.
RGA received a bearish ranking from Zacks, and I prefer that my trades and Zacks, where possible, be aligned.
The remaining symbol, PKY, looks fine at first glance, but based on the higher liquidity, I decided to give a more detailed look at CSE.
CapitalSource, headquartered in Los Angeles, California, provides commercial loans to small and medium-sized businesses in the United States, focusing on the healthcare sector.
It also provides financial services to consumers in California through its CapitalSource Bank subsidiary. It's a small bank, with only 21 branches.
CapitalSource is followed by only a handful of analysts, who collectively come down with a negative 43% enthusiasm index.
The company reports 8% return on equity with debt amounting to 70% of equity.
The record of the last 11 quarters shows that the company was profitable in 10. The loser was the 3rd quarter of 2011. Earnings have held steady quarter by quarter with the exception of the 2nd quarter of 2012 when they soared to many multiples of the earnings average. I assume a one-time event was the cause.
CapitalSource has surprised to the upside six times and to the downside five, most recently in the 1st quarter of 2013.
Institutions own 84% of shares and the price has been bid up to speculative levels; it takes $5.47 in shares to control a dollar in sales.
CSE on average trades 2.8 million shares a day and supports a moderate selection of option strike prices spaced a dollar apart with open interest in the two- and three-figure range. Front-month at-the-money calls have a bid/ask spread of 2.3%.
The options are just a bit too illiquid for me to trade; I would be hard pressed to construct a workable vertical spread. So if I open a position in CSE it will be structured as shares.
Implied volatility stands at 16%, near the floor of the six-month range. It has been fluctuating wildly since mid-August, with its most recent big move to the downside.
Options are pricing in confidence that 68.2% of trades will fall between $11.40 and $12.50 over the next month, for a potential gain or loss of 4.6%, and between $11.69 and $12.21 over the next week.
Call options today are trading at only 11% of their five-day average volume; puts are more active at 93% of average.
CapitalSource next publishes earnings on Oct. 28. The stock goes ex-dividend in December for a quarterly payout yielding 0.33% annualized at today's prices.
Decision for my account: Given the bearish nature of the chart, I don't see CSE as a decent bull play. I don't expect it to rise above the wave 5 peak of $12.36, which limits my reward to 3.4%. And in the best case among the most probable outcomes, the downside risk is down to $9.92, a decline of 38.2%.
A 1:11 reward risk ratio is just not something I'm willing to take on.
So I won't be trading CSE. If it breaks to the downside -- the lower boundary of the 20-day price channel is at $11.37 today -- then I would consider a bear play.
My 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. 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.
By preference I place my 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 decision decisions for his or her own account, and take responsibility for the consequences.
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