AAL: Head fake in the making

American Airlines Group Inc. (AAL) in March completed the middle leg of a rise from last August. It has since gone into a downward correction. It sent a bull signal on Thursday as an upward retracement within the correction to the downside.

AAL is a head fake in the making. The rise since April 15 will end soon with a reversal and decline as the correction enters its most active phase.

The Chart

The rise since August is part of a larger rise that began in Nov. 23, 2011 from $3.96.

Using Elliott wave analysis, I've labeled the rise from 2011 as wave 5 {+3}. The uptrend that began Aug. 28, 2013 from $15.28 is wave 5 {+2}.

Fifth waves are always the final portion of a trend, which consists of three waves up separated by two descending waves. The {+3} and {+2} degrees are quite large for the shorter-term trades I place, which generally last a month or two.

The key question for this chart is the internal analysis of wave 5 {+2} since last August.

By my count, the peak of $39.88 on March 10 marked the end of wave 3 {+1}, the middle wave of the series within wave 5 {+2}. The internal count of wave 5 {+2} is a bit unclear. I've drawn a trend channel in gray on the chart to lend some clarity to the price reversals.

Click on chart to enlarge.

AAL 3 years 3-day bars (left), 180 days 4-hour bars (right)

AAL is now in the process of correcting the rise from last August. There is no way to tell how deep the correction will go or how long it will last. So far it has been quite shallow, with wave A, the first in the correction, pushing briefly below the 23.6% retracement level, which is $34.07 on the AAL chart.

Should it go deeper, some common retracement levels are 38.2% ($30.48), 50% ($27.58) and $61.8% ($24.68).

There is no rule in Elliott disallowing a shallow correction. To the contrary, 4th wave corrections are often tend to move sideways rather than down.

Corrections come in three waves -- A, B and C -- with B being a retracement against the direction of the correction. I count AAL as being near the end of the B wave, with to be followed by a C wave to the downside that will break down into five waves internally.

Bigger picture, AAL suffered a huge decline from 2006 to 2008 and has since taken back 62% of the decline. I've called it an upward correction in three waves at the {+5} degree, with the decline from 2006 to 2008 being the A wave and the present upward move being the first waves, A {+4} within the B {+5} retracement.

Given the information available to to me, the chart could just as validly be labeled as a new downtrend in five waves at the {+5} degree, meaning that A {+5} becomes 1 {+5} and the present B {+5 becomes 2 {+5}.

The downtrend alternative presents greater scope for a very long-term decline.

But back to the present problem. If wave B of the base degree, which began in April, is nearly complete, the next move will be to the downside. That makes wave B rise a head fake and a sucker play. Given the fact that the base degree waves are taking about a month to run their course, the reversal should happen soon.

Options are pricing in confidence that 68.2% of traces will fall between $34.13 and $42.41 over the next month, for a potential gain or loss of 10.8%, and between $36.28 and $40.26 over the next week.

I've drawn those range boundaries in blue on the right-hand chart. The lower boundary is well positioned to contain a shallow horizontal correction. A directional correction would most likely push below it.

In any case, given the advanced state of wave B, I don't consider AAL to be a good bull play. I think it's likely to be loss-making, and so I can cut this analysis short.

Decision for My Account

I don't intend to open a bull position in AAL under my shorter-term rules. The chart analysis shows it to be poised for a downward move.

References

My shorter-term trading rules can be read here. My longer-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 practitioner 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.

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