I'll repeat again from my last Trader's Corner
column, that for the astute follower of chart patterns it is sometimes tough to figure which of differing bullish OR bearish chart formations to give credence to. Many times you simply have to wait for 'resolution' of one of these recognizable technical patterns.
A common pattern after a stock or an index has had a strong move, is for a sideways pattern where there are 2-3 or more highs and 2-3 or more lows that fall in the same area making for two straight parallel lines 'defining' the high and low end of a trading range. There are a couple of ways that 'technicians' talk about such patterns.
One is that sideways trading ranges that form after a strong move, either up or down, are often 'consolidations' of the prior trend. Such consolidations are part of so-called continuation patterns; i.e., after the pause in the dominant prior trend, the prior trend will resume or continue.
There is another way that such patterns are talked about, whereby the sideways trading range could represent a harbinger of an eventual reversal pattern. One type is where the preceding move was UP and the sideways trading range, tracing out a box like rectangle pattern is suspected of forming a rectangle TOP.
If the trend has been down, followed by such a sideways trading range that goes on for a while and traces out a rectangular type pattern, such a trading range is suspected of being a rectangle BOTTOM. Both the rectangle bottom and rectangle top end up representing reversal patterns which are CONFIMRED IF there is an eventual breakout below or above the low OR top end of the rectangle.
So, is this all that technical musings have to offer, the stock or the overall market could go up OR could go down! There are however two useful things suggested in terms of trading strategy relating to the foregoing discussion:
1.) A trading range that goes on for a while suggests buying the LOW end of the range with a tight stop and shorting the HIGH end of trading range, also with a tight protective exiting stop point.
2.) Also suggested is to look for call or put buying strategies after a breakout of the upper or lower boundaries of the rectangle. Moreover, the longer the sideways range goes on, the more significant will tend to be the resulting (upside or downside) breakout in terms of a next sizable move.
I don't usually buy stock or index options at the TIME OF the actual 'breakout' move up or down since the premiums get so inflated. Rather wait for a pullback in the case of an upside breakout or a subsequent rally in terms of a downside breakout. It's quite common for prices to come back to a prior up or down breakout point.
I'll provide and update a perspective on this recent strong market rebound in terms of the differing (bullish AND bearish) patterns that were leading up to it in some key index charts.
The S&P 500 (SPX) Index daily chart below shows a very clear cut rectangle pattern, which is starting to look like a bullish consolidation (a type of 'continuation' pattern) of the strong UP trend PRIOR TO the lengthily sideways move. HOWEVER, yet to come is a decisive UPSIDE penetration of the top end of the rectangle.
To date, the surest outcome suggested from the SPX chart was for a trade for a limited upside objective when SPX recently held the low end of the rectangle (and the 200-day moving average), with an exiting stop just below the prior line of support. A small amount of 'slippage' should be allowed; i.e., don't exit on SMALL dips below the low end of the rectangle, especially just intraday ones.
The further minimum potential for a breakout above or below the SPX rectangle is noted on the chart below and is equal to tacking on the 'width' of the trading range in point terms and adding or subtracting this amount from upper or lower lines.
The Head and Shoulder's (H&S) Top formation is a fairly reliable 'top' indicator, especially when seen in individual stocks. When this (H&S) pattern is seen in the major indexes, it has often proven wise to wait for a breakdown BELOW the so-called neckline as a 'confirming suggestion that another down leg is underway. A downside break below the H&S neckline would tend to confirm that the Head & Shoulder's pattern HAS traced out or represented a reversal type pattern.
A minimum downside objective is then equal to the distance from the middle HIGH to the prior lows (the 'neckline' between two 'shoulders' so to speak) SUBTRACTED from the breakdown point or where prices pierce the lower line.
As is the case with the strong rebound over this week in the S&P 100 (OEX) where the index has now pierced the last high or the top of the Right Shoulder (RS), the reversal pattern suggested by the possible H&S Top is NEGATED. Of course, getting back to the trading range concept, a new up leg is NOT necessarily suggested UNLESS the prior 444 OEX top is penetrated and for more than a single day.
In the case of the Nasdaq market, the pattern that was traced out was simply that of a top, interim or otherwise. What was not established in the Nasdaq Composite (COMP) was whether this was a TEMPORARY pause (a consolidation as part of a continuation pattern) and how MUCH of a pullback was going to occur.
What was traced out as outlined on the COMP chart below is the classic down-up-down or 'a-b-c' corrective pattern. This pattern, an a-b-c in Elliott wave terms, is usually a consolidation of the prior trend. That is, a 'continuation' pattern that suggests a pullback that will run it's course to be followed by another up leg that will go on to now highs, often decisive new highs.
While, the 'classic' three pronged a-b-c or down-up-down price swings often involves a second down leg ('c') that falls significantly farther than the first downswing ('a') this is not always the case, as is outlined on my next and last chart.
What IS the common thread to this (a-b-c) corrective pattern is that after the first pullback, there's another rally, but this is followed by a second decline. The middle ('b')rally looks like it could be a resumption of the prior advance. But, not so fast! The market is not so easy as this.
The first rally fakes out the bulls as selling resumes, another decline is seen, often carrying prices lower than the first downswing. This second decline tends to build up bearish sentiment. After this weakness runs its course, the bulls come back in on some news (e.g., better than expected Intel earnings) and rapidly bid stock prices back up again. The intermediate to major up trend then resumes.
Wouldn't you just hate to see a market that was so 'easy' that everyone makes money, especially YOU:- Unfortunately the market is not designed that way. Only the few, not the many, make a lot in the market and then (most importantly) KEEP it. Our OIN subscribers are hopefully of this type or will be with perseverance and continued study of market cycles and patterns!
I myself have never stopped being a student of the market.
GOOD TRADING SUCCESS!