Chart of the Week: Is the Next rally nixed?

by from interactive investor |

Having seen Next reward his contrarian approach in recent months, technical analyst John Burford reveals why he's not overstaying his welcome.

With the UK retail clothing sector pretty much in continued dire straits (partly from the 'Amazon Effect'), Next has been valiantly swimming against the tide almost single-handedly with good gains racked up in recent weeks.

But that is exactly what I foresaw back in May when I last covered it, where I offered specific price targets. That was a truly contrarian forecast with sentiment so bearish.

So did I have a crystal ball to enable that bullish prediction to come to pass?  Did I scour the company financials or perform retail sector analysis to glean insights into the strength of the company? Did I even use astrology to discover favourable aspects with planetary conjunctions?  Or did I maybe have a wild guess?

Curiously, these are methods some use to determine their investment strategies.

No, all I used was this chart of historic price action posted in my Chart of the Week of 14 May and a sense of the bearish sentiment extreme at the 2017 lows.
 

Source: interactive investor      Past performance is not a guide to future performance

This chart held valuable clues that enabled me to make accurate future price movements.  

Recall that gloom and doom stories had been swishing around prominent retailers for some time and seemed to reach a crescendo about a year ago when Marks & Spencer Group reported poor sales and the shares plunged to almost match their 2009 credit crunch lows around £2.50. 

That was the time when Next shares dropped to the £35.50 lows (wave 1 on above chart).  But with bullish sentiment on the floor, was this a great time to be buying in true contrary fashion?

If you followed the usual ‘fundamental’ approach, the answer would be Definitely Not.

But from that low, the shares staged a ‘surprise’ relief rally and in December, I was able to buy at £44 on an A-B-C pull-back in true 'Buy the Dip' style using a close stop.

And by May, I could set upper price targets based on the shape of the price patterns in the above chart.  My first target was the Fibonacci 50% level (pink zone) around £58.  

Recall the 50% retrace is a significant resistance zone where reversals often occur.  Thus, it is usually a good place to at least consider taking some profits. Your decision should include analysis of the character of the advance off the low.

This is what I wrote then:

"Prudence tells me to take at least some profit as a major target is within range.  That is a cool gain of £12 (28%). But is there more upside?"

It presented a problem – but a nice one to have. I continued:

"I have to note the weakening momentum into the current rally as a warning sign.  But so far, the immediate trend remains up and there should be more fuel in the tank to perhaps push it up to the Fib 62% retrace around the £64 area."

So was I lucky to see the Fib 62% target hit around the £64 area in June?  This is the updated weekly chart:

Source: interactive investor      Past performance is not a guide to future performance

Bingo!  Not only did I achieve the Fib 50% target but also the Fib 62% zone where full profits were taken.

Of course, the weekly chart is too coarse-grained for precise trade entries and exits so I used the daily for a more accurate analysis.  Here is the daily from the 2017 low:

Source: interactive investor      Past performance is not a guide to future performance

As the market climbed above the first Fib 50% target in June, I could then draw in likely tramlines (in pink) which projected the market would likely hit the upper line as it then would run into stiff resistance.

Also, the form of the advance is a clear three up – and that is always corrective and a clue to expect a renewed decline. 

When trading A-B-C corrections, it is usually unwise to overstay your welcome.

Then, as the market began testing the resistance in the £62 - £64 zone, I noted the very large momentum divergence was building — and that was a clear warning sign the advance was running out of steam.  I had better take the remaining profit there or risk a ‘sharp reversal’. I exited at the £60 level.

The entire campaign netted a profit of £12 on the first leg and £16 on the remainder – magnified many times when spread betting, of course.

And last week, the market began moving down off my target and broke a minor internal trendline (yellow) where many sell stops were obviously placed.  And it appears highly likely the lower wedge line will be tested soon in the £60 area.

Of course, the smart follow-on play was to reverse positions in anticipation of a new down trend (I missed that one!).

John Burford is the author of the definitive text on his trading method, Tramline Trading. He is also a freelance contributor and not a direct employee of interactive investor.

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