10.09.2022
A top-down analysis leads to the energy sector, which leads to the explorers & producers industry group, which leads to the company EOG Resources.
For educational and informational purposes only.
KEY TAKEAWAY(S)
From a longer-term perspective, 9-months to 2-years, we are watching for a major breakout above $140 in EOG Resources.
This will trigger a, potentially multi-month or multi-year, trading campaign, as long as the relative strength remains attractive.
In anticipation of this breakout, and with the idea of building a position ahead of this breakout, which of course may never happen, from a shorter-term perspective, 2-weeks or more, we have a classical coil pattern setting up.
LOOKNG FOR SECTOR STRENGTH
As market participants, we, for the most part, want to buy the strongest charts and sell the weakest. When considering strength and weakness, we must consider both the absolute and relative price trends.
Below are the S&P 500 large cap-weighted sector ETFs. These charts show daily closing prices, and the bottom panel shows the sector’s relative strength against the S&P 500 ETF SPY. They are in no particular order. Let's skim the absolute and relative trends.
Daily Sector Charts w/ relative strength. Click to enlarge.
Looking at the above charts, price is moving from the top-left to the bottom-right on every sector chart except for Energy. What about on a relative basis? There are some good-looking relative strength lines, particularly the Industrials, Energy, Staples, and Utilities.
Using another visualization method, here are the same sector ETFs plotted on a Relative Rotation Graph (RRG). For those unacquainted, suffice it to say, look at Energy. It is moving up and to the right, essentially at a 45-degree heading. This shows that both strength and momentum are getting stronger relative to SPY. For some more information on the RRG, click here.
Weekly Sector RRG. Benchmark: SPY. Click to enlarge.
Bringing this full circle, if we are looking for a long idea, the charts tell us a great way to own strength on an absolute and relative basis seems to be by looking at energy related stocks.
LOOKNG FOR INDUSTRY GROUP STRENGTH
Dow Jones takes the companies in each sector and further divides them into industry groups. In the case of the energy sector, Dow Jones divides it into 5 industry groups. These groups contain components of the S&P 1500, so small, mid, and large-cap companies.
The next chart is another RRG. This one plots the 5 energy sector industry groups relative to XLE. Like XLE relative to SPY, there is one clear industry group heading up and to the right. The Dow Jones Exploration & Production Index (DJUSOS) is gaining both relative strength and momentum.
Weekly Industry Group RRG. Benchmark: XLE. Click to enlarge.
So far, we have found the strongest sector and its strongest industry group. Now it’s time to find the strongest stocks in the strongest industry in the strongest sector. The DJUSOS has 125 names to choose from. Continuing to use the RRG, after filtering out stocks that are not rotating up and to the right, here are the remaining names which show increasing strength and momentum relative to their industry group.
Weekly DJUSOS Components RRG. Benchmark: DJUSOS. Click to enlarge.
CONSIDERING THE STRONGEST STOCKS
Taking a look at the RRG above, all of the stocks are showing improvement in both their relative strength and relative momentum. In his 2016 research paper, Optuma’s CEO, Mathew Verdow CMT CFTe, tested rotations using the RRG.
Here is Mathew's paper to download:
After analyzing at least 20,000 rotations, he concluded that the tendency is for rotations to continue clockwise. With a 92% chance that issues in the upper-right leading quadrant will rotate down and into bottom-right weakening quadrant, we might be better served looking at the issues headed 45 degrees in the top-left improving quadrant. His paper shows a 68% chance that the issues will rotate clockwise from the top-left improving quadrant into the top-right leading quadrant. Being in the leading quadrant shows the greatest relative strength and relative momentum, two things we want when considering a long idea.
Looking at the above RRG, this leaves us the ticker symbols CDEV, FANG, and EOG. EOG is listed NYSE which has been much stronger than Nasdaq of late. Looking at EOG Resources' (EOG) monthly chart, we can learn about its structure. EOG was accumulated through the late 90s, broke out in 2000, spent the first part the 2000s gaining more than 800%, underwent reaccumulation from 2008 until 2013, and then gained about 70% until it peaked in 2018. Since 2018, price has fallen into the March 2020 low and now rebounded all of the way back to the top of a possible reaccumulation range at the 2018 all-time highs.
EOG Monthly. Click to enlarge.
As with any price chart, It is possible that price will continue sideways, move lower, or move higher. Let’s zoom in and see if we can glean any clues from its daily chart. Looking at the daily chart below, it certainly brings that consolidation from the monthly chart into focus. While we do not have any confirmation that this trend will continue higher from the monthly time-frame, the daily chart does have us assume trend continuation. The textbooks teach us that we want to see volume and volatility dry-up ahead of a triangle or an accumulation completing. Looking at the chart below, despite the last 2 weeks, I see volume and volatility declining as the pattern forms.
EOG Daily. Click to enlarge.
The next daily chart considers momentum. If it’s true that momentum leads price, this speaks to an increased probability that a breakout will lead to testing the June all-time highs in EOG.
EOG Daily w/momentum. Click to enlarge.
PLANNNING THE CAMPAIGN
A plan, like a tree, must have branches. A plan with a single aim is apt to prove a barren pole. While I am not sure who's quote this is, I do love it. In this spirit, let's consider some branches of our plan.
From a longer-term perspective, at least 9 months to more than a year, we do not have evidence of a decisive breakout above the 2018 highs yet. If we believe this will happen, now is a good time to begin accumulating for a larger move. For the more risk averse, waiting for a breakout and then even a retest is a better plan. Using Fibonacci extensions, here is the monthly chart showing a target level of $224 should we see price close decisively above $140.
EOG Monthly w/fib extensions. Click to enlarge.
Back to the daily chart, there are several ways we can get involved. If we want to use the classical approach, we can set a buy-stop above the triangle with our first target at $148 which is June’s all-time high. Our second target would be the measured move of $185.50. If we do get a breakout above the June highs, we will think more about targets and bring in the Point & Figure methodology as well.
A more patient approach would be to wait and see If price retraces its most recent 2-week move before breaking out. Entering on a pullback with a buy-limit order closer to the triangle’s apex would certainly help with the reward to risk ratio.
If that does not happen, or if we want more confirmation from price, another approach would be to wait for a breakout and then a retest of around $130.
So far we have outlined 3 options: enter with a buy-stop above the triangle, enter with a buy-limit if price retraces its latest move, or wait for a breakout and and then a throwback around $130. Just to be thorough and prevent our plan from being called a barren pole, we do have to think about failures. If price does put in a failed breakout, we might have a short play down to $106 and potentially even $90. Only time will tell.
TRADE DETAILS
Target 1: $149.
Buy-limit entry: $120.5. +28.5.
Sell-stop stop-loss: $112. -8.5 1.74x ATR10.
Re/Ri: 3.35:1.
ATR10: 4.87.
EOG Daily w/trade setup. Click to enlarge.
WHAT'S NEXT?
We watch for price to pull back to trigger our entry, and then hopefully a subsequent breakout of its coil.
If price breaks out out without retracing, we will watch for a retest of the $130/$131 level or make s decision based on the future's price action.
If it pulls back and we enter as planned, we watch to make sure its rally remains in force on the way to $148 looking at price, volume, momentum, volatility, and relative strength.
If price breaks out and fails, we will reconsider our options.
The timeframe here is a few weeks initially, though if we get a real upside break that holds $140, we can start thinking about bigger picture long-term campaign type tactics.
As always, thank you for reading. This article is for educational and informational purposes only. Trade at your own risk. The author may or may not have a position in the securities mentioned. Read our full disclaimer here. Please reach out with any feedback or comments. I would love to know if you agree, disagree, or don't care at all. Louis@eastcoastcharts.com
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