There have been at least two big picture bearish technical
patterns talked about recently in some of the sophisticated market reports: that of a big Head and Shoulder's Top
formation and a possible Dow Theory
'sell' signal. However, the technical interpretations involved are still speculative or premature.
It is often if not usually the case that when the market takes a nose dive beyond what the bulls and media talking heads were expecting and where downside price targets become anyone's guess, the media will seek out a technical 'take' on what's happening. Maybe so and so at (fill in the blank) says well, really, there's this bearish Head & Shoulder's Top that, with the latest decline, now projects a huge further loss in the Market. Even back to the July lows of a year ago (2009). I'll look at that shortly.
I was going to write more this week on retracements, picking up where my 'basics of technical analysis' series as to how knowledge of key 'retracements' can be very useful in trading decisions. This prior article is in the Trader's Corner articles from June 10th and which can be seen again HERE.
Retracements were extremely useful at the last top as the 'leading' indexes, the S&P 500 and the Nasdaq Composite (COMP) each retraced half or a fibonacci 50% of the prior major downswing: the late-April high to the late-May low. The theory being, and as borne out by much experience, that when a rally falters at one of the key retracement levels (38, 50 and 62%), especially if the retracement is only a third to a half of the prior decline, look for the decline to resume.
Being that the market is going down like there's no tomorrow, I instead will look at technical aspects related to current events. First, a look is at the possibility of a Dow Theory sell 'signal' in terms of defining the primary/major trend (impacts long-term investors). Next, is to look at a possible major Head & Shoulder's Top formation.
DOW THEORY SELLSIGNAL?
A recent media example of a bearish technical article relates to the Close in the Dow 30 (INDU) below 9816, the prior closing low before yesterday's 9774 close; or today's 9732 close. And that this may then suggest to one or more of the well-known Dow 'Theorists' that the primary trend has now reversed to down; the first such sell 'signal' since the rally that began in March 2009.
In my 'basics' of technical analysis series I could well have started with Dow theory, since so many recognized truths of market behavior come from Charles Dow.
The basic idea in comparing the 30 Dow Industrials (INDU) to the 20 Dow Transportation Stock Average (TRAN) is that the two averages should confirm each other in price levels achieved in terms of defining the major trend as up or down. In the course of the advance from the lows of last year, when INDU made a new closing weekly high, there was also a new closing weekly high in TRAN at some point and the averages kept 'confirming' each other that way on the way up. During pullbacks one average might fall below a prior key low, but not the other average, which can keep you long.
The following chart illustrates how comparing the Averages in terms of new closing weekly highs or closing weekly lows has yet to generate a bear 'signal' since the 2009 lows. Until BOTH Averages match the other in their weekly (closing) lows in the current correction, there is no 'confirmation' of a major bear trend. It now seems all but certain that the Friday 7/2 weekly close in INDU will be under its prior Feb low (10012) close; see below chart.
My weekly chart of INDU and TRAN below show points where it looked like the major up trend might have reversed EXCEPT one Average didn't 'confirm' the other. In my interpretation of Dow Theory, the Dow Transports (TRAN) needs to close below 3822 in any week ahead to 'confirm' the bear market implications of the recent Dow Industrials (INDU) close below its 10012 closing low of February.
TRAN might wind up matching INDU in a new low below its early-February 3822 low but this hasn't happened yet and it might not. Saying that a Dow Theory market sell signal (a reversal of the primary trend) is near is premature. Moreover, closes that are properly compared in Dow theory are on a weekly chart basis only.
One major technical contemplation of a new bear market is premature, the other is a bit of a stretch, but it's a potent pattern when you see the triple headed top called a Head and Shoulder's pattern.
MAJOR HEAD AND SHOULDER'S TOP?
This is a potent sign of a top. A rally, an initial dip, followed by a rally that goes to substantial new highs, followed by another sell off traced out the so-called Head and Shoulder's (H&S). The Top variety traces out what you could imagine to be a person's head and their lower shoulders, with Left and Right shoulder's about equal like it is in people. The 'neckline' connects the two lows of the Left Shoulder and Right Shoulder.
When prices collapse for a third time to below the price level defined by the neckline, the rule of thumb is to then project a downside price target equal to the vertical distance between the top of the Head and the neckline, subtracted from where prices broke below the neckline on the last occasion. In this case, in the S&P 500 (SPX) a next-move downside projection becomes 863.
The interpretation that what I've traced out below is a big H&S top pattern is off in that some requisite conditions are not present in this chart below. The so-called left shoulder (LS) was simply a continuation of the prolonged rally. Nevertheless the downside this pattern would suggest as coming is a move back down to the lows seen approximately July a year ago. We'll see if July 2010 is so bearish; that would be a LOT more decline this time!
Most traders tracing out the above pattern on the backs of cocktail napkins late at night would probably be looking to use the Dow chart. Below, the Head & Shoulder's pattern looks more like what we expect. The Left Shoulder (LS) is more defined. The RS is not as well formed as the Left, but it still looks the part.
The basic problem with applying an interpretation of a bearish Head and Shoulder's pattern to such a long-term chart as weekly, is that the H&S pattern has been studied most as a short-term bearish reversal pattern of 3 months duration or less. The H&S top pattern is highly correlated to subsequent declines in the way that I measured them on these WEEKLY charts. But, it's a comparison between apples and oranges. The downside rule-of-thumb objectives 'work' relatively well on DAILY charts but the same pattern isn't seen enough on weekly charts to say what tends to be the outcome for a much expanded snapshot of time.
The downside objective of a break of the below neckline will translate into a move not only below 9000, but ultimately to the 8200 area, even if briefly. Such a major further decline would equal a fibonacci 62% retracement, which is a deep one. A fall of that magnitude isn't out of the realm of what happens when you get this kind of (H&S) 'triple top' pattern. However, support not lower than 9500 is my bet.
GOOD TRADING SUCCESS!