Stock Chart Pattern - Larsen and Toubro (An Update)

When I updated my analysis 10 months back, the stock chart pattern of Larsen and Toubro had been consolidating within a rectangular band between 1300 and 1750 for a year. I had advised readers to stay invested even though the stock seemed to be going nowhere. The very next day after my post on Jun 16 ‘10, the stock broke out above the year-long trading range on a smart rise in volumes (marked by blue oval).

The timing was fortuitous. Rectangular consolidation patterns are usually continuation patterns. The trend (in this case, up) before entering the pattern tends to resume after the break out. Let us check out the 2 years bar chart pattern of Larsen and Toubro to identify some classic technical signals:

The volume spiked up during the upward break out – which it should, otherwise the break out may be a ‘false’ one. The stock price pulled back to the upper edge of the rectangle – as often happens after a break out – and then quickly rallied 200 points. It touched a high of 1949 on Jul 26 ‘10, which turned out to be a ‘reversal day’ (higher high, lower close).

A sharp correction dropped the stock below its rising 50 day EMA, but the stock stopped short of testing support from the upper edge of the rectangle. The next leg of the rally reached a new high of 2117 on Oct 4 ‘10. Another ‘reversal day’ pattern led to a quick correction down to the 50 day EMA. A final bullish spurt took the stock price to a new two-year high of 2212 on Nov 4 ‘11. But the stock failed to test its previous bull market high of 2335 touched in Nov ‘07.

Note that as the stock price rose towards its 2 year high, three of the four technical indicators made ‘lower’ tops and one made a flat top (marked by blue arrows). The combined negative divergences was an advance warning of a likely correction. But the severity of the correction caught many investors by surprise.

The stock first fell below the 200 day EMA in Jan ‘11 and after a brief hesitation, dropped back into the rectangular consolidation zone. On Feb 10 ‘11, Larsen and Toubro’s stock fell to a low of 1463 – a 34% correction from its peak of 2212, underperforming the Sensex which corrected only 18%. Fortunately, the stock formed a ‘reversal day’ (lower low, higher close) pattern and climbed up quickly – only to face strong resistance from the support/resistance level of 1750.

Another sharp correction reached a slightly higher bottom of 1481 on Feb 25 ‘11, followed by an intra-day high of 1933 on Mar 7 ‘11 – but the stock closed down inside the rectangle and slid down to a slightly higher low of 1503 on Mar 21 ‘11. The subsequent month-long rally has several bullish signs:

The stock is trading above both its 20 day and 50 day EMAs; both EMAs are rising and the 20 day EMA has crossed above the 50 day EMA; the down trend line connecting the Nov ‘10 and Jan ‘11 tops has been broken; the support/resistance level of 1750 and the falling 200 day EMA were breached on intra-day basis twice; the bullish pattern of higher tops and higher bottoms continue from the low of Feb ‘11.

All these bullish signs are negated by the fact that Larsen and Toubro’s stock price is yet to close above the 1750 level or the 200 day EMA since it fell below both in Jan ‘11. Unless the stock closes convincingly above both (i.e. by more than 3%), the bears will dominate.

The technical indicators are showing weakness. The MACD is positive and above its signal line, but has stopped rising. The ROC is still positive, but is below its falling 10 day MA. The RSI and slow stochastic are above their 50% levels, but both have dropped from their overbought zones. The stock may consolidate within the rectangle for a bit longer.

Bottomline? The stock chart pattern of Larsen and Toubro seems to have found a bottom and is gathering strength to return to a bull market. The sale of its electrical products division to Eaton will bring in a massive amount of cash to the company. If Q4 results disappoint, the stock may dip further. That will be a good opportunity to enter/add. Risk averse investors should wait for a clear break out above 1750 to buy.

12 Sensex stocks displaying the ‘death cross’

The main reason why the Sensex isn’t showing a ‘death cross’ yet, is that only 12 of the 30 Sensex stocks are showing the ‘death cross’. The balance 18 are technically still in a bull market. For the uninitiated, the ‘death cross’ is the 50 day EMA crossing below the 200 day EMA on a price chart, signalling the beginning of a bear market. (The 50 day EMA crossing above the 200 day EMA, signalling the beginning of a bull market, is called a ‘golden cross’.)

Chart patterns of the 12 Sensex stocks displaying the ‘death cross’ (marked by blue ovals) are discussed below:

BHEL

BHEL is a PSU blue-chip that started correcting after hitting a peak in Oct ‘10. The correction in the Sensex from Nov ‘10 exacerbated the fall. The ‘death cross’ occurred in end-Nov ‘10, two days after the stock dropped sharply to an intra-day low of 2060. A strong pullback took the stock up to 2379, where it faced strong resistance from the combined 100 day and 200 day EMAs.

Though technically in a bear market, the stock is trying to build a base. A move above 2379 will create a bullish pattern of higher tops and higher bottoms. The RSI and slow stochastic are showing positive divergences, having reached higher tops as the stock made a lower top. Use the dip to accumulate.

DLF

DLF, the real-estate high flier, doesn’t really score very high on management ethics, accounting transparency or investor friendliness. The stock is in a long-term bear market. A brief rally took the stock to a 52 week high of 397 in early-Oct ‘10. That was an opportunity to sell. The ‘death cross’ in Dec ‘10 has restored the bear market. With the recent tightening of loans to real-estate players by banks and housing finance companies, you can forget about investing in this stock even as a contrarian play. It may be headed down to two-digits.

Hero Honda

Hero Honda was one of the stars of the bull market till its peak of 2094 in Apr ‘10. A technically overbought condition started a corrective spell. The confirmed news of Honda, Japan pulling out of the joint venture was given a thumbs down by the market. The uncertainty about the future has led to heavy selling. The ‘death cross’ in end-Jan ‘11 is signalling a bear market for this blue-chip. Avoid.

Jaiprakash Associates

Jaiprakash Associates has been in a down trend since touching a high of 180 in Oct ‘09. The ‘death cross’ occurred in May ‘10, confirming the bear market. The rally from Sep-Nov ‘10 was an exit opportunity. Launching huge projects and borrowing money by the truck-load seems to be the core competency of this company. The stock is headed towards low double-digits. Avoid.

Larsen & Toubro

It is a bit disappointing to see a blue-chip like Larsen & Toubro in this group of bearish Sensex stocks. It started correcting with the Sensex after touching a peak of 2212 on Nov 4 ‘10. The sharp fall in Jan ‘11 was partly due to the less-than-expected Q3 performance. The re-structuring into 9 separate companies has also caused some uncertainty in the minds of investors. The ‘death cross’ will occur tomorrow, but I would use this dip to accumulate the shares of this fundamentally strong and investor-friendly company.

Maruti Suzuki

Maruti Suzuki’s chart pattern has two ‘death crosses’ – one in May ‘10 and the other in Jan ‘11. What does it indicate? Technical analysis is not a science, and no rule is sacrosanct. The ‘death cross’ usually indicates the start of a bear market. But not in this case. The stock has been consolidating sideways since reaching a top of 1740 in Sep ‘09 – causing the ‘death cross’ to occur twice without entering a bear market. Yesterday’s low of 1170 formed a possible double-bottom. The RSI and slow stochastic are indicating a likely upward bounce. Accumulate.

NTPC

The NTPC stock chart pattern is also showing two ‘death crosses’ – the first in May ‘10 and the second in Nov ‘10. The stock has been drifting downwards since touching a peak of 242 on Dec 31 ‘09, and is in a bear market. The hype about the phenomenal growth and profit opportunities in the power sector has proved to be just that – hype. Avoid.

ONGC

The ONGC chart also has two ‘death crosses’ – one in Apr ‘10 and the other in Jan ‘11. The first one didn’t cause too much damage to the bulls. The current one is unlikely to do much damage also – because the FPO has been scheduled for Mar ‘11, and the DIIs are likely to buy at dips till the FPO goes through. This is a great company but the government’s meddling has messed up its operations. This is a major reason why I avoid all PSU stocks. Accumulate.

Reliance Comm

Where is the ‘death cross’ in the Reliance Communications chart? It happened more than two years back, and is not showing up in the one year chart pattern! The stock is in a long-term bear market and should ideally be removed from the Sensex 30 index. Only big-brother can bail this company out. Don’t go anywhere near this.

Reliance Infra

Reliance Infra chart also has two ‘death crosses’. The first one was caused by the sideways movement in Feb ‘10. The next one in Sep ‘10 signalled the bear market. Anil Ambani has proven to be a big bag of wind with a slow leak. If you are invested in this company, bail out now before it becomes too late.

Reliance Ind.

Reliance chart has two ‘death crosses’ as well – one in Aug ‘10 and the other in Jan ‘11. The first one was due to the sideways consolidation that has generated negative returns in the past one year. But the second one looks more ominous. The fall in Jan ‘11 has been steep and on increasing volumes. If Reliance doesn’t recover soon, it will drag down the Sensex with it. The technical indicators are hinting at a further fall. Wait for the correction to play out before entering. 

Tata Power

The ‘death cross’ in the Tata Power chart hasn’t yet happened – even though it has been marked in Sep ‘10. The 50 day EMA spent only a few trading sessions below the 200 day EMA due to the sideways consolidation, followed by a 52 week high. The current corrective spell may push the stock into a bear market. Wait for the correction to play out before entering.