A little more than a week ago, an active trader friend asked for my take on GOOG's chart. I don't trade equities with the exception of the occasional IBM trade. Still I agreed to look at the chart with the proviso that since I hadn't watched GOOG's chart on a regular basis, I didn't know whether it tended to adhere to evidence produced by technical analysis of a chart.
The procedure that I go through might be a good one to discuss here. The chart evidence will be old by the time you read this since I rough out my articles ahead of time, but that's okay. I am not presenting a trade suggestion, but rather just an example of how one might study a chart, and the passage of time gives you a chance to evaluate whether my process is valuable to you.
My first step when considering an equity's chart has nothing to do with the price chart. Before I trade an equity, I want to know whether any scheduled company-related events could derail a trade. A quick search turned up the news that earnings were just released on April 14, so an earnings report isn't looming. Out of habit, I also checked the short float, although I knew that GOOG's wouldn't likely be a problem. Unless a trader plans a directional trade that would benefit from a sharp, sudden move, I don't trade underlyings with a heavy short float. All it takes is a small gap up past a key resistance level one fine morning, and covering shorts will drive quickly drive prices higher and ruin a nicely performing trade. NFLX's heavy short float (20.43 percent of outstanding shares as of this writing) is the reason I wouldn't trade that underlying for anything other than a speculative trade, even if I did trade individual equities.
I also check an equity's beta, which is a measure of how much the stock moves in relationship to a comparison underlying, often the SPX. GOOG has a beta of 1.15, which means that it tends to be a bit more volatile than the SPX. By contrast, Avanir Pharmaceuticals, with its short float of 26.73 percent, has a beta of 2.42. On a percentage (of price) basis, it moves much more than the SPX, probably due to the relatively small number of outstanding shares and the heavy short float, as well as the nature of its business.
Next I check a point-and-figure chart to also enhance my sense of where a stock price might be going. At the time of this typing near the close on May 27, GOOG had closed at 520.90 but had a P&F downside target of 475.00 after a triple bottom breakdown on May 23. The following chart was found at Stock Charts.
Point and Figure Chart of GOOG, as of May 27:
For those unfamiliar with point-and-figure charting, StockCharts describes it as "a study of pure price movement in [which] time is not taken into consideration." Neither are volume patterns taken into consideration. You can find a fuller description of the process by searching online or reading Thomas J. Dorsey's in depth explanation in Point & Figure Charting.
Just as is true of any other form of technical analysis, P&F targets aren't always met. I don't use technical analysis to predict what will happen but rather to warn me of what could happen.
That's the background. No complicating earnings report is due over the next thirty days. The short float isn't too heavy. Although I think of GOOG as a volatile stock, the beta suggests it isn't too hot to handle for some.
Now I move to the weekly chart for another overview. Remember that this chart was snapped on May 27, so it's not current. I wanted you to see what I was seeing then and read the conclusions I reached as a result. Knowing what GOOG has done since gives you an opportunity to evaluate these procedures.
Weekly Price Chart of GOOG as of May 27:
Here we find that GOOG has been trading lower within a wedge-shaped formation. If I were bullish on GOOG, I'd think that was a bullish falling wedge, which typically breaks to the upside. If I were bearish, I would extend that lower supporting line back and see a distorted head-and-shoulders formation, with the requisite lower RSI at the head of the formation. Since I'm neither bullish nor bearish, don't know the individual stock that well, and just trying to get a reading on what's going on, I added my preferred nested Keltner channels and OBV or On-Balance Volume. Although the RSI has begun kicking up as GOOG approaches the converging support of two trendlines as well as last August's high, OBV hasn't begun to kick up at all on the weekly chart. If institutions were using GOOG's decline to support to accumulate stock, that would probably be happening. Again, this isn't proof of anything, but it certainly warns me that it's possible that this should not be interpreted as a bullish falling wedge. It's still possible that GOOG will drop deeper and widen that wedge into a descending price channel. If so, the nested Keltner channels and rising trendline on that weekly chart suggest that GOOG could drop as low as about 486, where the lower black channel line and the rising yellow trendline converge. The price could perhaps even drop that low while just following that blue trendline lower, in which case the movement would be just noise within that formation.
After I examined that chart, I reached the firm conclusion that there was no conclusion to be had just as of May 27. There's a difference in being wishy-washy, and in studying a chart and determining that there's not strong enough evidence to make a prediction. The only prediction I could make was that the further GOOG gets into that narrowing wedge, the more likely it is to break out in one direction or the other. Big news, huh? The P&F chart and the falling OBV certainly lend themselves to a more bearish than bullish interpretation of the chart, enough that I would want any trades to minimize downside risk. Beyond that, there was nothing much to be found here. I could make other observations relating to the nested Keltner lines, in that it currently looks more likely that GOOG will touch that 486-490 area before it rises above 550-560, but that setup could be erased by one week's action closing GOOG for the week above about 527-528. That observation may not carry much relevance for GOOG.
What do I know about any proposed options trades if I had gone no further than this? I would know that if I were setting up a balanced complex option trade such as a butterfly or an iron condor, I would want to be sure that I wouldn't hit my maximum pre-planned loss before GOOG hit 486 or climbed to 560 or so. I saw the possibility that GOOG could reach either of those potential targets. I wouldn't want those to be just my expiration breakevens, understand; I would want to know that if GOOG moved quickly to either of those levels, I wouldn't have hit my maximum loss and would still be able to adjust. Movement between those two points is just noise, the evidence on this chart suggests.
If I were a short-term trader looking for a directional trade, I would have to decide whether I wanted to wait to see if GOOG did drop down to 486-490 before I thought there was stronger bounce potential, and risk missing an immediate bounce back toward the top of the descending wedge. If I were trading on hopes of a rise through that wedge again, I would certainly want a tight leash on that trade, particularly since the daily chart (not shown here) shows that GOOG can gap sharply lower in the mornings. I think I'd want some OTM downside protection because of that diving OBV and P&F downside target.
If I liked straddles or other such trades, I'd recognize the possibility that GOOG could spend another few weeks in that ever-tightening wedge before it breaks out either direction. My long calls and puts would suffer, if so. A study of GOOG's 12-month volatility reveals that implied volatilities were in the bottom of GOOG's range over that time period. The same situation existed in early October, 2010, just before GOOG's implied volatility shot higher again as GOOG rolled over. While that's no guarantee that such price action will happen again, it may be important to your option strategy to verify that options are cheaply priced with respect to historical norms if your plan is to buy options. You don't want to buy options in a straddle or other such strategy if implied volatilities are high with respect to historical volatilites, because you're buying them at a premium then, and that premium can be sucked out by further price consolidation.
Just to ensure that my source was correct, I used another source to check GOOG's implied volatilities back in early October, before prices rolled over and when options were 49 days from NOV expiration, just as they were 49 days from JUL expiration on May 27, when this article was first roughed out. An ATM 530 call option had an implied volatility of 28.53, whereas an overall summation of volatilities by this source pegged implied volatility at 31.03. As of the day this article was roughed out, an ATM 520 call had an implied volatility of 24.15, 49 days before expiration, with an overall summation of IV's at 20.79. We may be comparing apples to oranges here because we all know that there's more fear in the markets in October and that vols tend to decrease in slow summertime trading, but at least we know by these measures that GOOG options were not outlandishly expensive. I haven't checked the skew of the options chain, and it's a possibility that it's much steeper a smile-shaped curve now than those ATM call options suggest.
Finally, a shorter-term chart.
Thirty-Minute Chart of GOOG:
RSI is neutral. GOOG has been chopping sideways, chopping back and forth across potential support and resistance levels, as tends to happen when underlyings are consolidating. It's above the top of the 5/26 gap lower, but just below the opening print of the 5/24 gap higher. Although I didn't draw the trendline on this chart, prices tested a slightly descending trendline off the 5/24 high, but it couldn't maintain levels above that into the close.
There just isn't much evidence here. It looks possible that GOOG could rise at least to the 525 level or fall at least to the 515 one, if not down closer to 510. The sideways chop has rendered all other support and resistance levels useless.
What's my conclusion? After retesting the 210 high last fall and early this year, GOOG has been trending down in a narrowing formation as implied volatilities drop. The P&F chart has already signaled a downside target of 475, but that descending wedge formation is typically bullish, so the evidence is somewhat contradictory from these two views. There's no rise in OBV to confirm the bullishness of that formation, however, so I personally wouldn't be able to call the direction of any breakout with any confidence at this point. Anyone choosing a direction should be prepared to step in quickly to stop losses in case GOOG breaks the other direction. Anyone who prefers balanced non-directional complex trades should ensure that they won't hit maximum loss before the first adjustment point or expiration breakeven is hit, a task that may be made more difficult by the lower vols. As of the original roughing out of the article, it might have been difficult to get enough premium from selling options when vols were this low, although I haven't yet checked the skew's smile shape. Perhaps it is turned up sharply so that there is premium in the OTM options that would be sold for a strategy such as an iron condor. I would certainly want downside protection in the form of OTM insurance puts if I were establishing something like an iron condor, however, since that's a negative vega trade established when vols don't seem to have anywhere to go but up.
To sum it up, these chart don't give a lot of evidence of the direction of a potential breakout. One looks due, and, at least over the last three years, GOOG has tended to trend one direction or the other during summertime months rather than consolidate all summer long.
That's what I wrote when I first roughed out the article. Has anything changed since then? On the weekly chart, OBV has ticked up a little. During this week, GOOG climbed to a high of 533.20 and dropped to a low of 521.50, ending the week fairly close to the point at which it opened the week, creating a small-bodied weekly candle indicative of indecision. As I wrote when I first roughed out this article, all movements within that narrowing wedge shape are now just noise. GOOG didn't break out, and anyone who had bought straddles would probably have lost ground due to GOOG continuing to chop around within that wedge's noise level, as I worried that it might continue to do for a while longer. So far, iron condor traders might have been happy by the week's development if they had been able to get far enough away from the action that the modest 12-point range didn't cause any angst. I would have recommended keeping a tight watch on such trades, however, because GOOG has spent a number of weeks in ever smaller ranges since the horrendous second week in April. Sooner or later, it's going to break one direction or the other. If GOOG had broken to the downside, and I'd been in a trade, I would have wanted to draw a supporting descending trendline that was parallel to the top descending trendline. Sometimes wedges break to the downside, only to broaden into a parallel descending channel. When that channel's support is hit, bounces can occur.
Remember that I offered no trade selections here. I am not trading GOOG, and, if I were, I wouldn't be trading this as this chart just isn't giving me enough information to form a good opinion about what happens next.