Charts Approaching Inflection Point

by Jay Pestrichelli on October 12th, 2012

After this week’s choppy market, we thought it made sense to see if there are any indications from the charts to help us decide where this market is going. On our blog post of August 23rd we made an opinion that indicated there could be an imminent pull back, but nothing to get worried about. Today we’ll continue that chart and see where the trends are taking us.
 
As outlined, we did get a little breather in the market, but not to the degree expected because as soon as Q3 was announced that possible reversal came to an end and the market rebounded upward and the S&P 500 (SPX) hit an intraday high of 1474.50. However since that time, despite Romney poll strength and unemployment dropping to 7.8%, the market has drifted downward. See Chart Below:
Today the SPX if falling below its 50-day moving average for the first time since late July we just might be seeing a reversal pattern forming. Expect more downward movement to the bottom of the channel outlined in blue above if we close today below 1428, the 50-daymoving average.
 
This isn’t necessarily a bad thing. Actually, many may view this as a buying opportunity. A continuing upward trend is a characteristic of a strong bull run.  The troubling indicator is if the market breaks this trend.  Closing below the blue trend line may indicate a larger pullback than and a breaking of support.
 
Two patterns may emerge and both aren’t pleasant. The first is to consider that the two peaks occurring around mid September and early October have formed a double top. Usually these points are stretched a little farther apart, but we do have to clear peaks here. This pattern can signal a top to the upward trend we’ve had since June.
 
The second patter is the dreaded and popular head and shoulders. For those of you unfamiliar with this pattern, here’s a screen shot of a hypothetical head and shoulders pattern from Wikipedia.
For the S&P, this pattern has been forming since early August, but is far from confirmed. We have the makings of the left shoulder and the head, but have yet to form the right shoulder. On the chart below we outline what that second shoulder may look like in the grey area and if it does indeed happen, we’ve also drawn where the market can retrace to that happens to be around the 1335 level.
This is one view to watch out for and a failed pattern is just that. Remember, technical analysis and pattern analysis aren’t nearly as exact as they sound, and I’ll state for the record that jumping a patter before it forms can be a dangerous game. So let it form and then use it as you see fit.
 
So what can we now expect?
 
Bottom line is we’re getting prepared for a decision time. In order to continue the upward trend, we’ll want to see support and expect that to come at the 50-day moving average or the bottom of the channel. Either way, that inflection point is coming in the next two weeks. Use that inflection to help form you bias. If no rebound occurs and that second shoulder starts to form, brace for an impact. There is a high probability that other technicians will see this forming as well and also start implementing sell programs. This means you’ll want to lock in hedged before they get too expensive and sell options away at tighter levels to help offset the potential sell off.


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