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Island Hopping

Here we'll look at patterns -- including islands -- and what they can potentially us about the market.

The Market

So we got the rally. Statistically there isn’t much to say. Breadth was good and the bears from yesterday have gone back into hibernation. I still think we are more apt to see an up/down/up sequence in the next few weeks.

But now I want to discuss patterns. There are many charts that will appear to have an island bottom after this week’s action. Let me explain what an island pattern is. It is when we have a gap down (or up) followed by a gap up (or down) that leaves either a day or a few days or weeks as an island. To be an island, there must be no trading on either side, which means there can be no connection to the prior price. That would make it a peninsula.

So let’s look at the PHLX Semiconductor Sector (SOX:Nasdaq) index. I hope you see Tuesday’s action (green arrow) is an island. Or we’ll call it a potential island. This is because the next few days will tell us more. If the SOX comes back down and fills that gap from Wednesday, the island goes away. This is because the water around it has been filled.

Why is this so important? Because an island bottom is a bullish pattern. An island top is obviously bearish.

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I know the SOX doesn’t look like a great chart right now. But that little top it broke down from measured to 1,650, which was the low on Tuesday. But let’s get back to the pattern. Let’s say we get my “W” pattern, where we come back down after a rally. Sure, the island goes away, but look at all that support around 1,625 from the uptrend line and the breakout.

I would love it if we come back down, break under 1,650 and the indicators line up bullishly, because I think it would probably be a good opportunity to buy.

Now let’s look at the island in the PowerShares QQQ Trust (QQQ:Nasdaq). It is not as obvious, there is a lot less water around the island, and so it is much easier to fill those gaps. But if the QQQs fall from here, won’t the pattern begin to look like a small head-and-shoulders top?

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You want to know the coolest thing? If that black line (the neckline) breaks, the top measures to the $192-$194 area, which is exactly where the blue line/breakout was.

Now let’s step away from technology and look at the Bank Index (BKX:Nasdaq). Do you see how Tuesday’s action cannot be an island? Do you also see how it might be considered a head-and-shoulders top, if it fails here and breaks Tuesday’s low? And if that were to happen, what do you think the measured target would be? I’ll bet you guys know: About $103, right where the uptrend line and the breakout come in.

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There is a reason I say we should hope for more downside. More downside gets the indicators lined up. More downside would surely get folks a lot more bearish, too. And as you can see, the tops don’t measure that far, but instead of seeing retests, I’m sure most would see bearish patterns.

The question is if the market will accommodate me.

New Ideas

For weeks now I have been pushing Verizon (VZ) - Get Free Report, and each time it came down to around $59. It has finally moved in the past week, but what I want to point out now is that I don’t think I would like it if it comes back down to that area again. It had a chance to break and didn’t. Instead, it tested the breakout. Another trip back down there and it would look like a failure, not a retest. My eventual target is still around $64.

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In biotech land, where everyone is now a fan, I have liked Amgen (AMGN:Nasdaq) and the iShares Nasdaq Biotechnology Index (IBB:Nasdaq). I now offer you an interesting base in an old stodgy biotech name: Gilead (GILD:Nasdaq). If it can ever get through those 2019 highs around $68-$69, there is resistance all the way up, but I think it would be a big deal.

As a side note, the target on Amgen is near $240 so it’s getting quite close to the target.

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I was asked if there is a head-and-shoulders bottom in the chart of the iShares China Large-Cap ETF (FXI) - Get Free Report. I suppose we can make the case for that, but the recent pullback makes it funky. Yet the blue line makes it interesting (very similar to the iShares MSCI Emerging Markets Index (EEM) - Get Free Report chart we have looked at recently). FXI will have to get up and over $41 to get any traction though.

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Today’s Indicator

The Volume Indicator is back at 52%, having reached an overbought reading just over a week ago when it tagged 56%). Once again, a reading back in the $40 area makes it oversold. So cheering for downside so it can get oversold.

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Q&A/Reader’s Feedback

Helene welcomes your questions about Top Stocks and her charting strategy and techniques. Please send an email directly to Helene with your questions. However, please remember that TheStreet.com Top Stocks is not intended to provide personalized investment advice. Email Helene here.

I remain hopeful that Amazon (AMZN:Nasdaq) is building a base. I will reassess that view if it breaks under $1,725 in a meaningful way.

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Altiud Minerals (ATUSF) is an interesting chart, because the top it broke down from measured to $8, and that’s where it found some footing. Now it is forming a small (still small) base. Even if it gets through that $8.75 resistance, there is a lot of resistance all the way up, so I don’t think it would be a smooth ride. Think of it like this: The top was approximately six months in the making, from March to August, which typically means the base should be about six months as well, a mirror image is typical. So far, there has only been four months.

I have drawn two blue lines on the chart on the left side. I ask you to put your hand over those lines all the way over to the left of the chart. Can you now envision how much better this chart would look if it can stay over $8 for a few months?

I like it, but you might need some patience.

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Zscaler (ZS:Nasdaq) is an interesting chart, because the breakdown from the top measured to the $40 and $50 zone (the upper line measured to $50 and the lower one to $40) so it met its objective. The top is six months in duration so the recent three month base is short in comparison (see ATUSF). But the chart appears to be forming a head-and-shoulders bottom, the gap from two weeks ago has been filled and a rally to fill that gap is not out of the question.

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