Chart of the week: Tesco in the bargain bin? by John Burford

In these articles, I will highlight a share that I believe has an interesting chart pattern. I am primarily a technical trader and use the methods I have developed that I call Tramline Trading. You can read more about my methods in my book Tramline Trading, which you can inspect here.

Most traders and investors make classic errors by chasing a stock near a top and then hang on to it too long during the decline. You will vastly improve your performance by timing your entries and exits more expertly – and that is what I hope to help you with.

My goal in these articles is to cover a share that has an interesting chart. I I developed my tramline system over several years to give me a set of rules which can provide me with trade entries at low risk. The low risk requirement was crucially important because no matter how firmly I believe in my trade, I could be wrong! And I wanted my wrong trades to hand me the smallest possible loss to my account. I figured the winners would take care of themselves.

My hope is that you glean useful ideas and employ at least some technical analysis to bolster your returns. In trading as well as investing, timing is a key factor in your eventual returns.
Is Tesco In the bargain bin and now a buy?

Today, Tesco (TSCO) is without a friend.

It must be one of the most hated shares in the FTSE 100. The reasons are well rehearsed, of course and I will not repeat them here.

In fact, the shares have been declining for many months. It made a high at the 380 level in April 2013 – eighteen months ago. It has been travelling on a one-way ticket down since then to the recent low of 164, a decline of 57%. For a huge rock-solid company selling food – basic staples that never go out of fashion – to lose value to such an extent is a remarkable achievement. So maybe Tesco isn’t so rock-solid after all.

In fact, I recall the time when they ventured into the USA with Fresh ‘n Easy and came a massive cropper a short period later. Major UK companies have a nasty habit of coming unstuck in the USA, don’t they? They are seduced by the apparently easy money to be made. After all, if the Beatles – that quintessentially British band – can conquer the country, what?s to stop us?

I once had an advertising business in the States and can tell you that it is a different place – they do things differently there. To succeed, you had better adjust your approach – and fast.

But that little Tesco episode rang alarm bells with me. The Tesco management were now fallible, and during a more competitive grocery market in the UK, they would be tested. And tested they are.

A recent article in a leading UK daily was headed: “Five Reasons not to buy Tesco”. That about summed up the recent mood. But note that this dark sentiment occurred after an eighteen-month bear market.

Were similar thoughts expressed eighteen months ago when the share price was at 380? Of course not. Who is bearish when the market is rising? Similarly, who is bullish when the share has tanked? But these are the best times to trade!

And that is the eternal dilemma of an investor. We are all excited when a share is rising and want to buy more and more. But that is precisely the time when you need to be wary of joining the crowd. Market tops are made when everything looks rosy – and bottoms made when there is blood on the street.
My analysis

So, is Tesco a buy here? Let’s take a look at the daily chart:

[chart removed]

On long-range charts, I like to see if I can spot any Elliott waves (if you want to learn more of Elliott waves, then go to my book.

And sure enough, I have a wonderful wave setup. The first move down off the 380 high is my wave 1, then a rally in wave 2. The market then started its main descent phase with the July – October period particularly strong to the downside. When I see this kind of behaviour, I suspect as the selling is getting intense, it is near to exhaustion – at least temporarily.

The long and strong wave down is fully characteristic of a third wave (see text, pp 87 – 9, 118 – 120), so now I have waves 1,2 and 3. Wave 3 ended on exhaustion selling in October and is currently staging a relief rally in wave 4 up. This is sometimes called a Dead Cat Bounce.
Outlook

If I am correct, wave 4 could last for a few weeks yet. I note that Wave 2 lasted for about 12 weeks from the wave 1 low, and I expect wave 4 to be of similar duration, taking the wave 4 top to land in December/January.

Typically, fourth waves are quite complex with many twists and turns. They are responsible for much whipsawing action and I usually advise spread betters to stay well away from fourth waves during most of their traverse.

According to Elliott wave theory, when a fourth wave tops out, the market will make another attempt at moving back down. This is when the fifth and final wave is put in taking the market to new lows.

Recent data shows that short interest was elevated, and I expect this to be corrected during the fourth wave period. Also, this is when many traders believe the worst is over and start to dip their toes in the water – and this provides the fuel for the fifth wave selling.

Here is my best guess over the next few weeks:

[chart removed]

The wave 4 rally could extend to the 220 – 240 area (pink highlight) but that should be it. Then, wave 5 will take it down below 160. Momentum today is elevated (yellow highlight), so we could see a re-test of 160 in the next few days, but support should come in and send it back up.

Better buying opportunities will be presented, I believe. And patience should be rewarded because after my fifth wave is in, I expect a hefty rally phase.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.