Head and Shoulders Pattern Confirmed

by Jay Pestrichelli on November 12th, 2012

Last month in our post titled Charts Approaching Inflection Point we outlined the possibility and a picture of what a head and shoulders patter might look like. Well unfortunately it happened almost exactly as we drew it up. Here’s an update of that chart with current data
The SPX fell below the uptrend support line, defined the head and shoulders neck line and after the election shot lower. The break below the second shoulder of the pattern happened about two weeks earlier that drawn, but understandably the election accelerated it. Despite the way Friday and this morning are shaping up, if the pattern plays itself out, there are a few more percentage points to go on the downside.
 
This pattern would be completed somewhere between 1340 and 1330 on the SPX which is currently at 1381. That’s about 3 to 4% more on the downside. This pattern is considered as a reversal and typically signals an overall market decline. The length of that decline is unknown, but we do subscribe that this time that will be for a shorter period than usual due to the accelerated second shoulder.
 
However for the bulls, there is still one last frontier that can provide support, and that’s the 200-day moving average.
 
A look over the past 2 years shows how this level has shown both support and resistance for this index and we’re at the point now where if it holds, the head and shoulders formation could fail to complete and the market could rebound back up to the bottom of the channel if formed from June to October.
Just as it did in the beginning of June this year, the 200-day moving average can be a point where the sellers get tired and the buyers see opportunity. Moving averages aren’t the most exciting indicator, but there’s a reason everyone talks about them; and that’s because time and time again, they continue to show how the market feels.
 
There is one other piece of promise for the bulls and that’s the VIX. It has dropped the last couple of days showing less fear is being priced into options and that it may signal a break from the emotional let-down that the markets experienced. We’ll see more about that in the upcoming Wednesday post about the cost of hedging, but the bottom line, is the sophist iced money of the options traders isn’t projecting doom and gloom in the near future.


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