Tim Bovee, Private Trader: AA: A light in the fog

Alcoa Inc. (AA) has been a strong rise since last year. But its chart is blanketed in fog. Only a resistance level provides a clue, a lighthouse cutting through the mist with a red light of warning: Mariner, beware. Treacherous reefs lie ahead.

The Chart

I find the AA chart to be so filled with ambiguities that it is impossible to do a persuasive Elliott wave count. The nearer-term chart is undifferentiated as to degree, and the longer-term chart has magnitudes of change that make the straightforward count seem unreasonable.

Click on chart to enlarge.

AA 10 years weekly bars (left), 15 months daily bars (right)

Taking the near-term chart, to the right, first.

If the rise beginning Feb. 10 from $10.83 is correctly considered to be a 3rd wave, then there is still considerable upside potential.

If it is a 5th wave, as shown in the "Alt:" count, it is well extended and thee is far less upside potential.

It all depends upon how wave 4 to the downside in the primary count is labeled (in the yellow oval). It is certainly deep enough to qualify as a {+1} degree wave.

Turning to the long-term left-hand chart.

The Great Recession low of March 2009 began an upward, five-wave rise in nearly every stock I've analyzed. Not in the case of AA, however. It counts best as a counter-trend correction to the upside, meaning that the 2009 low, far from being the end of a downtrend, was instead the 1st, massive wave down of a bear market of epic proportions.

The reason for my count is the clear division of the rise from 2009 into three waves. That means it cannot be seen as an impulse wave, in the direction of the trend, but must be a corrective wave.

The subsequent decline, wave X {+3}, moves below the B {+3} terminus, and so cannot be included in a five-wave impulse analysis.

It counts best as a Flat -- a sideways correction -- that is extending, and may extend for years.

(The Apocalypic view has been applied in recent years to the markets as a whole by some excellent students of Elliott, so I don't discount it as an impossibility. It's just, the AA count differs from what I've seen in most charts I've analyzed over the past few years.)

The key to chart has nothing to do with Elliott wave analysis. The March 2011 high was $18.47. I've marked that level on the left-hand chart in red. stands 4.8% above the most recent highest high.

There is bound to be large resistance at that level, which was previously the end of the rise from 2009 into 2010.

If a sideways correction is indeed underway, then the price is already within the zone where a reversal is likely.

Even if the price rises above that level, I would be far from convinced that an uptrend is other way. Corrective waves are notorious for their whipsaws.

I think the resistance alone would be enough to warn a chartist of any stripe away from this bull signal.

Odds and Yields

AA has completed six bull signals since the rise from July 2013 began. They split evenly, three being successful and three not. The winning trades on average gained 11.2% over 40 days; the losers were down 2.3% over 12 days.

A 50% success rate is nothing to cheer about. However, the yield spread is 8.9%, which is quite good.

The Company

Alcoa, headquartered in Pittsburgh, Pennsylvania, is the world's third-largest producer of aluminum and a major supplier of engineered products, with operations in 31 countries.

Engineered products, such as precision castings and aircraft/industrial fasteners, accont for nearly half of its market capitalization.

Analysts are less than enthusiastic about Alcoa's prospects, coming down collectively with a negative 20% enthusiasm rating. Zacks Investment Research, however, gives it a bullish ranking.

The company reports low return on equity of 3%, with debt on the high side, running to 52% of equity.

The company has reported one loss in the past three years, in the 4th quarter of 2011. Since then profits have been steadily higher in the peak quarter of each year, although there is great variation among the quarters.

Alcoa has surprised to the downside twice, most recently in the 4th quarter of 2013. The other quarters have surprised to the upside.

However, earnings for the past 12 months are negative, with an earnings yield of negative 12.9%. The dividend yield is small, at 0.52% annualized, compared to 2.45% for the 10-year U.S. Treasury notes.

Growth and earnings estimates, combined with the dividend, imply a price of $4.39, meaning that AA is selling at nearly triple the "fair" price. I've marked that price on the left-hand chart in purple.

The stock is selling at a discount to sales. It takes 88 cents in shares to control a dollar in sales.

Institutions own 66% of shares.

Alcoa next publishes earnings on Oct. 8. The stock goes ex-dividend in November for a quarterly payout of 3 cents per share.

Liquidity and Volatility

AA on average trades 8.4 million shares per day and supports a wide selection of option strike prices spaced 50 cents apart, with open interest running to four and five figures.

The front-month at-the-money bid/ask spread on calls is 5.6%, compared to 0.5% on the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 29%, compared to 12% for the S&P 500 index, and has been rising from its low of 25% since Aug. 20 within the context of a broader downtrend.

AA's volatility stands at the 18th percentile of its one-year range, meaning the trades most likely to succeed will be structured as long option spreads bought with a debit.

Options are pricing in confidence that 68.2% of trades will fall between $15.71 and $18.57 over the next month, for a potential gain or loss of 8.3%, and between $16.45 and $17.83 over the next week. I've marked the one-month range on the left-hand chart in blue.

Contracts are trading actively today and are skewed toward calls, which are running at nearly four times their five-day average volume. Puts are running at twice their average.

Decision for My Account

The chart count may be ambiguous but the resistance level has total clarity: This stock is in reversal territory. Perhaps it won't reverse, but it's a chance I don't want to take.

The fundamentals are far from bullish, which is another argument for avoiding this trade.

I won't be opening a bull position in AA.

-- Tim Bovee, Portland, Oregon, Sept. 4, 2014

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.

From time to time 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 shorter-term 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.