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First sell signal in upward trend

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The last couple of weeks, we've talked about the point/figure pattern of "the first sell signal in the upward trend" often times being a good buying opportunity for bulls. The current market environment is ideal for such a pattern for bulls to be nipping away at. While a bull isn't really buying the "sell signal," the trader/investor is looking for a reversal higher after the sell signal was given.

We see this setup today in the Biotech Index (BTK.X). Last week we were monitoring the bar chart and the rising 50-day moving average. This was our first chance to get a real sense for how bullish this sector and perhaps how aggressive the MARKET might be as one of the early leaders off the bottom in late September/early October experience a pullback. The recent test of the rising 50-day moving average occurred on Wednesday and so far the BTK.X has bounced like a champ.

Biotech Index Chart - $10 box

Today's trade at $580 in the BTK.X is enough to get the point/figure chart back into a column of X's. With the BTK.X showing a 3% gain and leading the sector winners today, this would be a group for bulls to be adding some positions near-term. I like the strategy of picking up 1/2 positions long in here. Then we can see the potential triple-top buy signal at $630 (or spread quadruple-top) as a place to round out position to full by adding another 1/2. This "strategy" allow the trader to commit some capital to the group, but forces the trader/investor to only commit further once he/she experiences success at $630. Too many times, a trader/investor "rewards" a stock with his/her hard earned money when the stock/index doesn't really deserve it or has yet to prove itself worthy. Using this technique allows the trader to only reward a position with more money once it has proved itself and clear and concise action points. As you can see from the above chart, the first sign of trouble would occur with a trade at $530. If stopped at that level for a loss, the trader may also understand how the 1/2 position bullish instead of full position here at $580 would lessen the blow to a bullish position.

Why buy a sell signal?

When I first started talking about this pattern or scenario for buying a "sell signal" our primary observation or tie to this pattern would be that Treasury bonds needed to see selling and therefore generating cash that may be slated for stocks. We continue to see that action today and therefore a bull is more likely to be buying some weakness.

Since the Biotech Index (BTK.X) was the first group we identified in late September/early October as a group where bulls really seemed committed to (this group did NOT violate its April lows) then this is a group I feel institutions are still committed too.

The "sell signal" in the upward trend most likely occurs due to shorter-term traders locking in gains on profit taking. This isn't "stupid" as we're all here to make money. But often times, that sell signal is a "duping" where committed money looks to buy the weakness. With the BTK.X trading just above its upward trend (bullish support, blue +) a good lower-risk and high potential return trade is at hand.

"Inside days"

Now is a great time to begin looking for some biotech stocks were we've seen a pullback. Using the action in the Biotech Index (BTK.X) as a guide, we look for stocks in the group that have pulled back into consolidation, set up an "inside day" and then give the action point of bullish on the break above the previous day's high.

One stock that may be setting up the "inside day" trade in Myriad Genetics (NASDAQ:MYGN). Friday's range was $52.77 to $57.33 and today's action has been "inside" that range. MYGN may be a stock to watch for tomorrow. One might "think" that a BTK.X move above the $630 level might take place with MYGN trading above its recent relative high of $63.64.

For some info on the "inside day" technique, you can get an idea of how to implement it from the "Bailey's Basics" section of the web site.

Jeff Bailey
Senior Market Technician
Option Investor

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