Telstra has had a strong rally since August. However, upside momentum has faltered in the new year and after today’s profit announcement and unchanged dividend there is potential for a butterfly reversal set up in this stock.
I have outlined the butterfly on the chart below. This is a relatively uncommon chart reversal pattern but one which many followers consider to be amongst the most effective.
Mike McCarthy has posted a piece today commenting on today’s results and the dividend. You can access this via the link below.
As you can see from Mike’s analysis, any significant decline in the Telstra price will result in attractive dividend yields. I must confess that reading Mike’s analysis was enough to make me doubt the chances of a fruitful short set up in this stock.
However, I have found that often the most successful technical set ups come when they seem to fly in the face of what seems a sensible valuation based on the consensus view. These can be just the circumstances in which a market is poised for a substantial reaction to bad news should it come along.
Some text book approaches to this pattern require “Fibonacci symmetry” where all the corrections and trends within the butterfly pattern meet Fibonacci ratios. However, the approach taken here is to rely simply on the butterfly shape which tells a story of “retesting” behaviour and rising indecision.
I define a butterfly pattern as follows
- There should be a well established and strong trend leading into the pattern (e.g. the swing up to X on this chart
- There is an initial correction ( X/A) followed by a correction of that swing down ( the A/B move on this chart)
- The next swing down must fail and be confined within the initial X/A move. Put another way the B/C downswing must be smaller than or confined within X/A.
- This is followed by a rally that moves past the previous high at X. However, this must not move too far beyond X. It is thus basically a retest of the previous high.
- Finally to complete the pattern price demonstrates weakness by overlapping down through the previous peaks at X and ideally also B.
Looking at this chart price has complied with all the conditions of the pattern except the final overlap. One way of approaching entry strategy would be to sell on a close below the dashed red line which represents a zone of support below the overlap zone.
It may pay to remember that Telstra is due to go ex-dividend on 20 Feb. All things being equal the stock will decline by 14c when it goes ex the dividend. On that basis a typical approach would be to use this entry trigger only if there is a set up prior to the ex-date.
The initial stop loss on the chart is just above the previous high. If that is taken out the set up has failed. Also if price moves above that level without falling below the overlap point the set up is no longer valid
If we get a set up I’ll post some thoughts on profit objectives and opportunities to move the stop if a downtrend does develop