Companies like McDonald's have proved resilient during the recession, with many believing it would benefit as people adjusted eating habits in response to falling wages and looming unemployment. As the fastfood giant gets ready to unleash quarterly earnings Thursday, will its golden arches lend support to the stock's performance?
Often there is a high correlation between heavyweight stocks and the performance of the underlying Index. One trading strategy is to buy stocks that mimic the index.
McDonald’s was a counter-bear strategy. As a defensive investment play, the strategy did payoff, but its very counter-market advantages now work against it.
The stock does not show the same behavior of rally recovery, about 17%, as seen in the underlying index, about 35% for the same period. This underperformance also effects the impact of earning reports.
The dominant feature on the chart is the constraints and barriers that define the price behavior. The upper trend line slopes downwards from the August 2008 high. The lower trend line slopes upwards from the October 2008 low. This creates a broad equilateral or symmetrical trianglepattern.
Chart patterns point the way to high probability outcomes because they capture the psychological behavior of market participants. There is a temptation to succumb to the childhood fantasy of making patterns and pictures from clouds in the sky and this needs to be avoided when applying chart pattern analysis.
Each chart pattern has a perfect or ideal configuration. When this configuration appears the reliability of the chart pattern is at its highest. The further away the chart pattern moves from its ideal structure, the greater the reduction in reliability. If you define a chart pattern loosely, then the reliability is reduced substantially.
The perfect equilateral triangle has three features. A well defined down sloping trend line. A well defined up sloping trend line. And thirdly, a base that is created by 1 to 10 days of price activity that moves substantially in the same direction. Perfect triangle patterns do not have zigzag bases. The base for the triangle pattern in McDonald's has a zigzag base. The high starts in August 2008 and the low of the base is created in October 2008. The price direction between the pattern high and the low points is confused with many up days and many down days.
The result is that this equilateral triangle pattern with McDonald’s has reduced reliability. For analysis purposes the pattern provides a broad basis for analysis rather than a well defined target.
The role of the two trend lines is more significant. The resistance line suggests an upside target for any positive earning release. Price can move rapidly to near $60.00 but there is a low probability of a successful breakout above the resistance level. There is a higher probability of a retreat towards the middle area of the equilateral triangle pattern near $57.00.
A poor earnings report is constrained in the same manner, with good support near $55.50. A sudden fall to this level has a high probability of rebounding from the trend line support.
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The equilateral triangle pattern is a pattern of indecision. Neither the bulls nor the bears are in charge of the market. The height of the base of the triangle is measured and used to project upside and downside targets based on the breakout above or below the trend lines. This is not a useful analysis strategy with McDonald’s because the equilateral triangle pattern is not a high quality pattern. However the broader indecision conclusion is still relevant.
The limits placed on the rally and retreat process suggest price will continue to be constrained inside this boundaries when the earnings report is released. A breakout above the upper trend line is not a raging bullish signal. Resistance consolidation sets a target near $64.00. A close below the lower trend line is mildly bearish and sets a downside target between $51.00 and $52.00. The downside risk is limited by nearby support areas.
For the Investor:
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The lethargy of the equilateral triangle pattern is not easily overcome. The longer term outlook is continued tracking within the confines of the equilateral pattern. The real interest will develop when the stock moves further towards the apex of the triangle pattern in October. Then traders could be looking for a whopper.
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