Following up on the 'success' of predictions suggested by measuring implications of chart patterns that formed prior to the recent decline and subsequent upside rebound.


"You wrote this month about some technical methods of figuring downside targets for the recent correction. I've lost track of some. How did the chart calculations work out?


I wrote about some downside expectations for certain chart patterns in my Trader's Corner article from 3/12 and on other chart analysis from my last two Index Wrap commentaries (3/12 & 3/19). I'll pull together these various charts and commentaries into one place here as I think its worth following up to see how expectations were relative to how things have gone to date with the major indexes. First, from the aforementioned 3/12 Trader's Corner article of mine from a couple of weeks back (see link above):


"The micro view is my anticipation for a second market decline that was at least equal to the first downswing; OR, alternatively, a second decline greater than the first. The common down-up-down or "a-b-c" correction is 1.): where the second down leg (c) ends up being at least EQUAL to the first decline (a) AND 2.): where the second downswing is 1.38, to 1.5 to 1.6 times greater than the first decline (a). That is, where a second decline in a down-up-down corrective pattern has a Fibonacci relationship to the first downswing.

The aforementioned scenario of a longer second down leg in a correction is not seen so much in a strong bull market. A steeper decline on the second down leg 'c' is more likely, within a major bullish trend, AFTER a long-standing uptrend starts to see greater selling pressures, especially after the major indices get to an 'overbought' extreme."

Here's how the downside corrective patterns, in terms of the relative lengths of the two down legs in a down-up-down ('a-b-c') correction, played out to date for 4 of our major stock indexes. As you can see from my notations, the second 'c' down legs, were at or quite close to the fibonacci relationships (to the 'a' down leg) I described on 3/12:


There is another PATTERN that was bearish and had a measuring implication that turned out to be quite accurate. My commentary below is from 3/12 also:

"I covered the topic in depth in July on both falling bullish wedge patterns and the rising bearish wedge variety, as part of my technical analysis series (#9 in a series) that can be viewed/reviewed online by clicking the link HERE.

Formation of a 'wedge' pattern generally signals a trend reversal or correction ahead. The variation that exists with the pattern you'll see next is that of a broadening rising or ascending wedge. As can be seen in the archived article (link above), the more common bearish rising wedge is where stock or index prices move gradually higher and two converging trendlines slope up but narrow in to an end point or apex. In the broadening rising wedge, the pattern is reversed, as wider price swings create a megaphone shape with the narrow end BEGINNING the broadening wedge pattern instead of near the end of the formation.

With the S&P 500 daily chart, the trendlines have the requisite 3 or more 'touches' to the upper and lower trendlines. Both trendline slope up, but more volatile price swings broaden out to create what we recognize as a megaphone shape."

As you can see from my up to date chart above of the S&P 500 (SPX) as pictured among 3 other major indexes, SPX got down to 1249! Pretty amazing to be within 4 index points of a target suggested after the downside trendline break (of the below wedge pattern) of 3/10 and 3/11.

As far as the above forecast, it's not ME folks; I was just using an historical technical analysis 'measuring' technique. The 'broadening' type wedge pattern seen above IS an uncommon formation compared to the usual wedge pattern (trendline narrow in rather than widen out , but I had this pattern before over the years. Technical Analysts seem to get better the older they get as they've seen more market cycles. It used be kind of a macabre joke among our very small group of New York analysts that you had to wait for someone to die for there to be a job opening.


(From my 3/12/11 Trader's Corner article)

"My final chart, of the Nasdaq Composite, doesn't have quite the same distinct shape of the Rising Broadening Wedge pattern that was seen above with SPX; the upper trendline doesn't have the common 3 (or more) highs that 'define' the trendline; at least in the conventional way of drawing trendline ONLY through the highest highs. However, more unconventionally, an internal trendline touching the MOST number of highs, takes on more of the expected shape.

With COMP, the 'measuring' implication for a minimum move back to the start of the ascending broadening wedge formation suggests a further downside objective to the 2650-2645 area. This objective looks quite feasible, especially given the weakness suggested by the recent (and second) downside price gap."

3/21/11 UPDATE:

The Nasdaq Composite got down to 2603 for a brief intraday low, so fell to a bit lower than the 2645 downside objective forecast and highlighted above in the COMP chart seen in my 3/12 Trader's Corner. As soon as the lower trendline of the wedge pattern got pierced, rallies back to the trendline (to around 2720-2725) suggested a shorting opportunity in the Nasdaq; e.g., buying puts in NDX or shorting key bellwether tech stocks, etc.


From my 3/12 Index Wrap column:

"There's another way to measure downside objectives with a different and fairly reliable bearish chart pattern that completed its formation this past week: that of a Head & Shoulder's top as seen on the hourly charts of all the major indexes. I highlight in my first chart the Nasdaq 100 (NDX) Index. The way to do the downside measurement is described in more detail in my 7/9/10 Trader's Corner piece which can be seen online HERE.

The measurement is fairly simple: the distance from the top of the 'Head' (the center top of 3) to the neckline is subtracted from where prices later broke below the extended neckline. NDX in this calculation has an implied 'minimum' downside objective to around 2240. Resistance is implied on a move back up TO the neckline as noted by the red down arrow."

Now, a downside measuring objective for any Head & Shoulder's pattern is always a MINIMUM objective and the actual low often overshoots this mark. In the example provided by NDX, the recent intraday low was 2189 versus a minimum 2240 objective. Still, even exiting around 2240 made for a quite profitable trade. With the H&S top pattern it tens to be so reliable in suggesting a top that some traders will initiate a bearish options play as SOON AS the THIRD top sets up; i.e., the Right Shoulder ('RS').


Going still further in a my trip down recent memory lane, specifically, my 2/24 Trader's Corner, I pointed out an aspect to the S&P 500 Volatility Index (VIX) that we should look for:

"... a number 3 item on our technical check list (for a bottom) is whether something unusual has developed in a related but not strictly price related indicator, especially with volume, volatility or trader/investor (bullish/bearish) 'sentiment'. Staying with the S&P 500, there's a technical aspect worth noting with the VIX chart of the daily CBOE options volatility levels for the S&P 500.

When looking at spikes in the daily VIX that takes this indicator to 5% or move its 10-day moving average, there's a history in this bull market anyway, of such spikes in VIX occurring prior to the resumption (or continuation) of rallies; as highlighted with the yellow circles."

Now using sharp upward spikes in VIX was tricky as we had FOUR such spikes in VIX that were greater than 5% above a 10-day VIX moving average as you can see in my updated chart (3/21/11) below. However, consistent with my strongly held belief and long time market experience, there is a 'cluster' aspect to bottoms.

The spike in VIX seen above to around 29 was not in and of itself a sign of a bottom, but when TWO other key indicators (my CPRATIO and RSI indicators) hit 'oversold' extremes, the combination tends to strongly suggest that the market is at or near a bottom. See the lowermost highlights (yellow circles) on my sentiment (CPRATIO) indicator and the 13-day Relative Strength Index (RSI) on my last chart below: