May 13, 2005

To me, trading without knowing the fundamentals is like crossing the street blindfolded. It would make me “fear” for my safety. And, that “fear” factor tends to impede good decisions. Almost every one of my successful trades required full understanding of the technicals, the macro economics and the micro company specific implications. The failed trades were usually the ones I went in without doing such due diligence - I was just hoping to get lucky, and that's not the right business approach.

I’ve no idea why it’s often said that the utilities are inversely affected by the rise and fall of interest rates. And, it’s beyond me that the utilities sector would be regarded as a “defensive” play or a safe haven in a down market. This chart shows that for about one year, from Oct 2001 through Oct 2002, the Dow Utility actually was going down with the bellwether 10-year T-Note yield (green line), and that happened to be the period when we’re headed into a recession. It didn't look all that "defensive" to me, and there's no sign of any inverse correlation with the interest rates.

This past scenario coincides with the state of our current economy. Please read my weekly Chartmentary or prior posts pertaining to my thesis of a coming recession, or at least an economic slowdown. Upon further review of the utility sector, I discovered that NONE of the recent highs of the Dow Utilities were confirmed. The last high that was confirmed by RSI and MACD occurred about 3 months ago, in February.

This is the chart I looked at on 5/5/2005, just a day before I set up the trade. As you may see, while the Dow Utilities were making higher highs, both the RSI and MACD were going the opposite directions. This served as an assurance that this was one of the last sectors yet to go down with the market.

Dominion Resources (Symbol: D) was only one of the stocks that I had selected in the utilities sector. The reason for documenting this trade was due to our trade group discussion of the Head and Shoulders technical trend reversal pattern. Here's the chart used in that discussion. I think it's quite self-explanatory.

Although this wasn’t one of those massive Head & Shoulders patterns, it was a neat example with all the classic H&S formation characteristics. Please see chart annotation for details. One important thing for us traders or investors is to confirm these characteristics before we jump the gun. I used the 9-Day RSI (upper pane) and the Volume (lower pane) to obtain the confirmation for this particular trade.

In any case, this H&S formation provided us with a target price of approx. $68-$69 range, which happened to be the approximation of its 200-day simple moving average.

Thus, the trade..... Continued to Part II