Watch Out For Shooting Stars

By Joey Fundora | January 04, 2012 AAA

The stock market closed off its highs today after a strong gap higher. While the indexes finished solidly in the positive column, the soft close was clearly seen in many individual stocks. A great deal of stocks closed near their lows after pushing higher earlier in the day. The result is that many stocks formed what is commonly known as a shooting star pattern.

This pattern usually signifies exhaustion on the part of buyers and can often lead some sort of a reversal. Sometimes the reversal only lasts a few days as buyers step back in on weakness, but other times it is the canary in the coal mine signaling that something is wrong in the stock. If you think about the price action that causes this pattern, it reveals a change in momentum. Basically, longs were not strong enough to absorb profit taking after a push to new highs and were overwhelmed by the close.

A good example of a shooting star is the candle that formed on January 3 in Dollar Thrifty Automotive Group (NYSE:DTG). DTG broke out of a base to start 2012 on a high note, but reversed and closed near the open, which also happened to be near the lows for the day as well. Any trader buying the breakout at the open was quickly underwater and longs who were banking on a breakout may act to protect what profits they still have. Ultimately, it is still too early to know if this will result in a reversal or if DTG simply needs more time to consolidate. The $70 level is a key area to watch as it has been acting as resistance since December. DTG has been following the 200-day moving average since overtaking it in late November, and break under $70 would likely lead to a test of the 200-day moving average again. (For more, see The Basic Language Of Candlestick Charting.)

Cyberonics, Inc. (Nasdaq:CYBX ) had a similar reaction to its breakout attempt as well. CYBX had been flagging for the last two weeks of 2011 and kicked off the New Year with a high volume breakout. However, by the end of the day, CYBX had pushed under its open and was back within the flag. While it still maintained a positive close, it was certainly not a strong day. Traders must now watch the lows of the flag near $33 to see if CYBX is forming an intermediate top or simply extending the flag.

One of the strongest sectors on the first trading day of 2012 was the oil service stocks. This didn't stop Exxon Mobil Corporation Common (NYSE:XOM ) from forming a shooting star though. It also cleared a flag on a bump up in volume, only to close well off its highs. XOM did manage to stay above the flag and its gap, though, which was a positive. While a gap fill is likely, it is possible that XOM holds on to its breakout and continues higher. $84 is a level I would keep an eye on as a breakdown under the flag would imply a possible test of the $82 level.

Coca-Cola Company (NYSE:KO) also formed a shooting star after breaking out of a flag. KO has been acting very strongly for several weeks as it rallied from a false breakdown near $64 to break out of its base in mid December. It rallied and started flagging at the tail end of 2011 just under the $70 level. Unfortunately for bulls, KO failed to hold its breakout on its first attempt. This may simply be a case of moving too fast for KO, as it has been heading higher with little consolidation since mid December. This shooting star may simply be a warning that more consolidation is ahead.

The Bottom Line
While a shooting star or topping tail is certainly a negative or bearish pattern, it is important to note that it is not an outright sell signal. Being a simple one-day pattern, it is more of a warning sign that bulls lost the battle for that day. It often leads to either more consolidation or a more serious decline, and the important thing for a trader to note is how it behaves in the days following the pattern. If the stock can quietly trade sideways, it will often resume the breakout after resting for a few days. However, if the stock continues to see high volume selling, or more failed breakouts, then the chances of a top become much more likely. It will be interesting to see what 2012 brings, and watching how these stocks react to their opening day reversals will be a valuable clue. (For more, see Analyzing Chart Patterns.)

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Charts courtesy of stockcharts.com

At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

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