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.