Interactive Investor

Chart of the week: A blue-chip trade

7th March 2016 11:50

John Burford from interactive investor

Aviva - Is it a short here?

I confess, I have a long-standing aversion to insurance companies (unlike Mr Buffett, famously) and this is the first such company I am covering for Chart of the Week.

Aviva is a massive giant with tentacles in many areas of finance, not just insurance. Revenue is running at around £36 billion and it's currently engaged in a buying spree of mainly overseas insurers.

But, once again, it is the chart that attracts my eye.

In general with the FTSE index, the shares have declined this year as the global slowdown has combined with stress in the credit markets which has induced selling. But this month, the FTSE has staged a remarkable recovery from deeply oversold bearish sentiment levels.

Recently, some "good" news has emerged from Aviva in the form of an announced dividend increase and an effective cost-cutting programme.

But the main focus in recent days has been on the UK pensions fiasco perpetrated by a Mr G. Osborne. He first announced a proposed shake-up of the tax treatment to pensions, but then has backed down in the face of fierce opposition.

That little exercise induced a more positive stance late last week and hence the recent run-up.

But with the darkening background the financial world faces with proliferation of negative interest rates that many central banks are "experimenting" with, investment returns for major insurers surely face a massive headwind.

So is this rally a "buy the rumour, sell the news" event (BTRSTN)? We have seen many of these this year - and I have pointed out several here.

As always, I go to the charts. Here is the 10-year weekly chart to put the current position in perspective:

This should be a familiar overall pattern - a strong five down in 2007-2009 and then a lengthy counter-trend rally in an A-B-C form with the C wave making its high in 2015 with a final high on the Fibonacci 62% retrace of the big move down.

As I have noted many time before, this "five down/three up to 62% retrace" has applied to a great many shares - and they all carry the same message. It is that the C wave high was the final counter-trend rally high prior to a big collapse to below the end of the five down. That is the high probability outcome.

So has the most recent rally offered an opportunity to position for another down leg? Let's zoom in on the latest action:

The decline to the 400p level was stopped when it hit Fibonacci 62% support (always a good target for market turns!). The decline off the C wave high can be equally considered the start of a five down, or a complete three down. The outlook for the first option is a renewed slide in a long and strong wave 3, or a move to new highs in the second option.

Do I have any clues as to which option is best supported by the price action? Let's focus in even closer:

I have a tentative tramline pair (in blue) with the market hitting the upper resistance line and the Fibonacci 50% resistance. The rally is an A-B-C, so far.

Outlook

If the general market starts down now, Aviva will surely follow. It has hit resistance at the meeting of the Fibonacci 50% and upper tramline, so the odds favour a decline near-term - and it would confirm the BTRSTN scenario. Shorting around here could be protected by a close stop because if this is incorrect, the market would surely continue towards the 480-500p area.

And, if that occurs, the fog would descend on the chart! A bearish outcome would not be precluded, but from a slightly higher level.

Update on Rolls-Royce

I covered Rolls on 15 February and noted it was ripe for a large rally phase. I noted the prominent island reversal at the low. This is what I wrote then: "The trend is now up. Last week, the shares made a high probability turn at the 500p level."

This was the chart I showed then:

And right on cue, the shares have steamed ahead to close last week at the 720p level - a full 44% above the February low. That is the power of chart reading - and being able to identify classic chart patterns, which the island reversal certainly is.

Here is the update chart:

I have now discovered a lovely tramline pair (missing from the earlier chart) which solidifies my earlier analysis for a very bullish outcome. The upside break of the upper tramline with the huge gap was a classic example of the bullish message contained by my Tramline Trading Rule (see text Tramline Trading).

Outlook

Now, the market has hit the Fibonacci 38% resistance and is also inside chart resistance from last year's congestion zone, so a pull-back of some kind can be expected. This is where short-term trades will be looking to take partial profits on their longs, especially if spread betting.

If the general market starts a decline near-term, it is not out of the question that the market may attempt to close the gap below 600p before looking to resume its advance. That is one serious option. The other is that the market may dip a little from here and continue on its way in what may turn out to be an A-B-C counter-trend rally.

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