Tuesday, December 3, 2013

AAP: Wave of destruction?

Advance Auto Parts Inc. (AAP) broke above its 20-day price channel on Monday and confirmed the bull signal today. I see the rise as a retracement to the upside within a downward correction that has further to go before completion.

AAP's most recent push to the upside began Oct. 9 from $80.28, a move that carried the price to $106 on Oct. 31.

My Elliott wave count shows that rise to be a degree below wave 1 to the upside of my base degree. The wave 2 {-1} correction from the Oct. 31 peak has completed wave A {-2} and is retracing upward in wave B {-2}.

Elliott wave doctrine argues that wave C {-2} will commence after wave  B {-2} completes its work. The B wave mustn't rise higher than $106; if it does, then my count is wrong. Under the Elliott rules, it could well stop short of that level.

Click on the chart to enlarge.
AAP 2 years daily bars (left), 62 days hourly bars (right)

C waves are typically the strongest component of a correction and can devastate positions placed the expectation that the B wave was in fact the start of an uptrend. (B waves are the Elliottician's term for what most traders call a head fake.)

The maximum for wave B {-2} stands 3.6% above today's open. Typically, B waves will retrace from around 40% to 80% of the A wave that came before. AAP is at the 79% level today. That argues that a decline can't be far away.

What's with the curly braces in the wave labels? Click here to find out.

But there's a gotcha. Wave A {-2} on Oct. 31 began its decline from the $106, the starting point for wave 2 {-1}. That peak was quite excessive, topping 6% above the prior day's close.

The spike's rise and decline occurred within a single hour on the day the company announced earnings that were in line with expectations.

There is a temptation to toss out such outliers as anomalies -- computer glitches or fat fingers or gremlins or space aliens -- who knows.

But that hour shows a volume bar on the chart asserting that 1,230 shares changed hands. The spike has substance. It was real and any Elliott wave analysis, if it is to be honest, must take that spike into account.

It is a crucial issue on this chart. The present B wave retracement cannot exceed the start of the prior A wave.

If I ignore the spike, then wave A {-2} begins six days earlier, from $102.74, below the present price. Under that scenario, the A wave start has already been exceeded and the count is incorrect.

I've chosen in my count to stay true to the data. Tossing out the spike would likely mean that wave 1 {-1} is still in force, giving AAP quite a bit more upside potential.

Trading the markets is no science. The markets are a complex tangle of forces, systems and motivations. The charts provide a window into the results of that tangle but can never unravel the tangle itself.

This is AAP's third bull signal since wave 5 began in July. The two completed trades had split results, with the successful play yielding 16.9% over 28 days and the unsuccessful one losing 5.2%, for a wide, 11.7% win/lose yield spread.

Big picture, AAP has been on the rise since Feb. 25, 2003, when it hit a low of $12.33. The present wave of high degree, wave 5 {+2}, began June 27, 2012 from $60.87,

Advance Auto Parts, headquartered in Roanoke, Virginia, provides auto components on the aftermarket. When you go to replace something on your car, there's a chance you'll go to one of Advance Auto Parts' 3,800 stores scattered around 40 states.

The story is that people kept their cars longer during the recession. The question is whether they'll go out and buy new cars rather fixing old ones now that the recovery is underway.

Analysts collectively come down with a negative 7% enthusiasm rating for Advance Auto Parts' prospects. Certainly the financials show a company doing fantastic business, with a 31% return on equity and debt at 41% of equity.

Earnings the past two years have peaked in the 1st quarter, and this year's was below the corresponding quarter a year earlier. However, the second and third quarters came in above their year-ago counterparts.

Advance Auto Parts has surprised to the upside eight times in the last 12 quarters, and to the downside four times. The last downside surprised was in the 3rd quarter last year.

The earnings yield is 5.32%, comparable to that of other specialty retailers.

Institutions own 93% of shares, which are priced near parity; it takes $1.17 in shares to control a dollar in sales. Shares are priced at 19 times earnings.

AAP on average trades 820,000 shares a day and supports a wide selection of option strike prices, with open interest running to two and three figures near the money. The distribution of open interest could make it difficult to construct some types of bullish options spreads.

The front-month at-the-money bid/ask spread on calls is 5.6%.

Implied volatility stands at 22%, in Quintile III of the one-month range. This means that volatility is neutral.

Options are pricing in confidence that 68.2% of trades will fall between $97.96 and $111.12 over the next month, for a potential gain or loss of 6.3%,and between $101.38 and $107.70 over the next week.

Call contracts are trading today at 8% below their five-day average volume, while puts are at only 38% of average.

Advance auto parts next publishes earnings on Feb. 3. The stock goes ex-dividend on Dec. 18 for a quarterly payout yielding 0.23% annualized at today's prices. The dividend yield combined with earnings brings the total yield to 5.55%.

Decision for my account: The chart is a deal breaker. I'm seeing a rising B wave with limited upside potential, to be followed by a declining C wave that, typical of its kind, will be devastating to bull positions, truly a wave of destruction.

Faced with that prospect, I don't intend to open a bull position in AAP.


My shorter-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 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

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 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.

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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