As a companion piece to my Tuesday article on rectangle patterns and given that there has yet to be an upside OR downside breakout above or below the upper and lower trendlines, I was asked as to what other patterns or indicators might provide clues for the next significant price swing. The rectangle top is not uncommon as a 'signal' for the formation of a top.

As I noted in my Trader's Corner article of the other day (12/15), some traders assume that a sizable and prolonged multimonth advance into a sideways pattern like this is more likely to suggest a TOP than it is a consolidation of the prevailing trend. However, in and of itself the rectangle is 'neutral' in terms of suggesting either an impending bullish or bearish outcome. The safest strategy is generally to initiate new trades in the DIRECTION of a breakout, up or down.

When I looked today at the number of tops that consisted of repeated rally failures in the same area, it does seem that a rectangle pattern at the end of a long strong advance seems to have a somewhat greater probability of being a top formation than yet another pause in an uptrend. General Electric (GE) at its Sept-Oct 2007 peak is an example of a rectangle top.

Once into a decline, formation of a sideways rectangle does often become a consolidation pattern prior to a resumption of the prior move as seen below. The dominant trend prevailed and by July-September 2008 the trend was DOWN in GE and the market.

V-bottoms are more common than reverse-V shaped tops just as there seems to be more examples of rectangle tops than rectangle bottoms in stocks and stock indexes (commodities markets are another story!). There ARE both types and I haven't studied a wide enough sample yet to weigh the odds of this current pattern being a top, but it seems that the sideways trading range of recent weeks could have the bearish interpretation of a rectangle top. Time to also look at other patterns and indicators that are suggesting a sizable correction may lie ahead.

In a major advance, there are often THREE major up legs interspersed with TWO corrections. Corrections worth waiting out if you want to try to buy into the next low OR corrections worth trading such as by buying puts.

As to other patterns and indicators that might be interpreted as suggesting a reversal or counter-trend move, I've noted on the chart above one of them. Sometimes a bellwether stock like GE for the S&P or Cisco Systems for the Nasdaq will form a top (or bottom) ahead of the overall market.

I have a chart example for each of the following aspects, one above and the rest below. The list of other patterns and indicators that might suggest an impending correction would include:

BELLWETHER STOCK ACTION AS AN INDEX PREDICTOR

RETREAT FROM A KEY FIBONACCI RETRACEMENT LEVEL

RETREAT FROM A PIVOTAL LONG-TERM TRENDLINE

POSSIBLE PRICE/INDICATOR DIVERGENCES

A ROLLOVER OF MOMENTUM SEEN ON LONGER-TERM CHARTS

I've noted before that there is a long-term S&P 500 (SPX) down trendline that the index seems to be having trouble piecing and is seen on my next chart. Moreover, this is occurring after SPX has gotten into the area of a 50% retracement of the major 2007-2009 bear market decline. It is not unusual, at least from a technical perspective that SPX may be struggling to make further upside progress.

The key support in the Nasdaq 100 (NDX) index is the low end of the highlighted rectangle at 1750. A decisive downside penetration of this level would suggest further downside potential of 50-65 or more points.

The bearish divergence seen with the RSI indicator is also highlighted at the bottom of the NDX daily chart. As prices have gone sideways and repeated highs have been seen in the same area (around 1815), there has been a corresponding decline in relative strength.

Looking further at the Nas 100 (NDX), this index has led the overall market until recent weeks and has retraced more of its 2007-2009 decline than the S&P. NDX has retraced what I consider a 'maximum' amount of the prior decline, short of going all the way back to re-test the prior high; i.e., back to the 2200 area. The 62 to 66 percent retracement zone is what I consider the 'danger' zone; for a pullback in the case of a retracement of the prior decline.

In terms of the wave pattern or structure of the common components of price move, a bull market uptrend often consists of 3 major advances, interspersed with two corrections. (A major bear market decline has usually just TWO down legs, interspersed with one sizable rally.) In the NDX weekly chart below, I've highlighted the first TWO up legs, and the ONE intervening sizable corrective pullback so far. One more sizable correction, followed by one more sizable advance, would complete the pattern for a first big and prolonged bull market trend. A corrective pullback is 'due' so to speak, or at least should not be surprising.

Going back to the importance of trendlines, the long-term NDX up trendline would be pieced on a sustained move to below 1755.

Last but not least of the other patterns and indicators that I outlined above, we're seeing the beginning of a possible rollover of the major momentum from up to down. The MACD or Moving Average Convergence Divergence indicator is at its most useful when applied to longer-term WEEKLY charts. Seen above, assuming there's no sizable rally tomorrow (Friday) to close out the week, there is the beginning of a bearish crossover of the two MACD lines and a result of slowing upside momentum. Like the ball thrown up in the air, which 'hangs' at the top of its arc for a moment before starting back down, this could be a tipping point leading to some further substantial downside for the market.

SUMMING UP:

The current and ongoing trading range being seen in recent weeks in key major indexes, which has the appearance of a rectangle pattern in chart terms, hasn't yet resolved itself as a bullish (consolidation) omen or into a bearish (reversal) outcome. However, a compelling assumption is that a top has or is forming. This interpretation is reinforced by a number of other facets of chart/technical analysis. 'Confirmation' awaits by whether key support levels give way.


GOOD TRADING SUCCESS!