I wrote my last Trader's Corner
column (12/17/12) when it looked like downside potential, based on a Head & Shoulder's top
pattern that had been traced out on the hourly
S&P 500 (SPX) chart, was more than it turned out to be. This before the Fed made its latest announcements on tapering their bond buying and intentions on short-rates.
More often than not, technical patterns in stocks and the indexes that shape up before major economic and policy announcements are made, will tend to 'predict' or be consistent with those reports' bullish or bearish implications. But, of course, the market has surprises for us at times!
Besides the typical 'reliability' of a chart formation like an apparent double top, double bottom, rectangle bottom, Head & Shoulder's top or bottom, key upside or downside reversals, etc. there is a further consideration that chart patterns tend to be more predictive in longer-term charts than shorter-term time frames.
For example, a daily chart pattern that shapes up over weeks suggesting a top formation, will tend to be more reliable than basing a significant top prediction on a 60-minute chart. A weekly chart pattern suggesting a bottom formation will tend to be more reliable in predicting a major upside turnaround than if the same pattern is seen only on a daily chart basis.
I was looking at the highlighted Head & Shoulder's (H&S) top pattern seen below on the hourly S&P 500 (SPX) chart BEFORE SPX bottomed at 1768 and then reversed strongly to the upside, decisively piercing expected resistance at the H&S neckline. This in turn implied that the hypothetical downside 'minimum' downside objective suggested by the hourly Head & Shoulder's top pattern to around 1753 was not going to happen or 'work'. An objective implied by a chart formation that often or usually works out is a pattern 'failure'.
IF the same top pattern as seen above was seen on a daily chart basis, I would rate the odds of a minimum downside objective being achieved as being greater than a prediction based on the hourly graph. Nevertheless the SAME rule for both hourly, daily or weekly charts: exit strategy targets based on the pattern if prices don't do what's predicted by an H&S top pattern; specifically exit if there's a decisive upside penetration of the H&S 'neckline' BEFORE the downside price objective is realized.
AN EXAMPLE WHERE AN HOURLY CHART PATTERN 'NAILED' THE OUTCOME:
This next chart, also of a Head & Shoulder's top pattern traced out on an hourly chart basis in the S&P 500, was from my Trader's Corner column of 8/15/13; this column, like all such prior ones, is seen in the 'Trader's Corner' archive via a top tab on the OIN Home page. I point out here that the H&S top (and bottom) patterns, regardless of the chart time frame used, can also be quite reliable in terms of a predicted outcome; i.e., here, a projected 'minimum' downside objective to 1660.
MORE THAN A 'MINIMUM' OBJECTIVE IS MET:
The hourly SPX chart below continues further past the time frame shown in the chart above and a downside objective is met that's beyond the projected 'minimum' downside target of 1660 suggested by the Head & Shoulder's top pattern; i.e., SPX reached 1628.
The subsequent double bottom low that formed in the 1528 area also turned out to be quite potent in terms of the subsequent strong rally into mid-September that initially carried to over 1720. Subsequently of course much higher SPX levels were seen.
I haven't yet exactly demonstrated that longer-term chart patterns are often MORE conclusive in suggesting future price targets when there are chart-predictive patterns. Let me move on to some longer-term weekly chart patterns and how 'reliable' they've been in suggesting longer-range objectives!
DAILY SPX CHANNEL SUGGESTS NEARBY OVERHEAD RESISTANCE:
The daily SPX chart has traced out a well-defined multimonth uptrend price channel as seen next that implies potential upside resistance coming in around 1852 currently.
Upper trend channel boundaries are based on lines parallel to the dominant UP trendline and are NOT considered as key to measuring potential 'resistance' as is the (lower) UP trendline as suggesting technical support in a dominant uptrend. Nevertheless, such upper channel lines (in an uptrend) often act as an area where interim tops form or as an area where upside momentum at least SLOWS.
Channel lines that form on intraday charts are valid for shorter-term time frames. Usually, daily chart channels do well in defining the upper and lower trading parameters in an uptrend or downtrend. 'Usually' reliable daily chart patterns may have to be re-examined in accelerated runaway type moves and the longer-term weekly chart becomes more important.
Long-term weekly chart trend channel construction is a next level of measuring potential major resistance and is often a guide to exiting bullish options strategies when prices bump up against an upper channel line. However, in a MAJOR bull move, implied upper weekly channel 'resistance' may need to be re-thought as in the current case with the tech-heavy Nasdaq Composite (COMP). This past week has seen COMP pierce its upper channel boundary as the same CONTINUED steep rate of climb carries on from when COMP reversed higher from its last pullback to its (lower) UP trendline in November of last year.
There is also a prior pattern for UPPER extremes in the 13-week Relative Strength Index (seen above) to suggest a price zone where COMP will be at or near an interim top and to starting a downside pullback/correction. This is seen in the number of occasions in months prior when RSI high extremes were reached (and for upside reversals on LOW readings). This same pullback/reversal pattern has not been true for some time now in the current runaway advance in the Nasdaq. The weekly chart is the definitive take on tech stocks being in a major or primary uptrend with accelerating upside momentum.
RELIABILITY OF LONGER-TERM 'PREDICTIVE' TYPE CHART PATTERNS:
A good example of a weekly chart pattern that has proved to be quite predictive and potent as a predictor of the current exceptionally strong bullish trend was the key upside reversal highlighted on the SPX weekly chart seen next.
To date SPX is UP 8 percent since the 'KEY' S&P 500 weekly chart upside reversal; i.e., a substantial new low followed by a Close above the prior week's High. The + 8% gain to date that has followed is measured on a weekly Closing basis from the week ending 10/11/13 until this week, although I am writing one day shy of this week's Close of 12/27/13.
THE DOW BREAKS OUT ABOVE ITS WEEKLY 'RECTANGLE' PATTERN:
You will no doubt recall how the broader market indexes like the S&P and especially the tech-heavy Nasdaq market were trending higher while, for the period highlighted below in the weekly Dow 30 (INDU) chart, the Average was trending sideways in a broad trading range. This broad trading range pattern formed a 'rectangle' pattern in technical analysis terms, that has implications for a 'minimum' upside move to the 16600 area (which is close to being realized).
Such a 'minimum; upside objective is based on a prediction that a next up leg as measured from the UPPER end of the upside breakout of the rectangle at 15660 (at the line of various prior highs) that's 'at least' equal to the prior 930 move from the low to the high end of the trading range. This calculation is seen on the weekly chart.
If we look at the broad multiyear uptrend price channel that INDU has been in, the current intersection of the upper end of that channel, and possible 'resistance', is to over 17000. Stay tuned on that possible target!
GOOD TRADING SUCCESS!