June 30th, 2009
A regular reader and friend of this blog asked “…is a head and shoulders top forming in SPY?” It’s a relevant and important question for two reasons: it addresses the market’s future direction and it focuses on chart reading techniques. Not being one for short, quick, direct answers, I’m going to take the opportunity of having been asked it, if you’ll indulge me, to get on my soapbox and expound a bit.
This is a glass-half-full or glass-half-empty sort of discussion. I’ve read elsewhere from other bloggers (DistressedVolatility, BullzandBearz) that based on their view the market is forming a head-and-shoulder reversal top pattern:
The right shoulder of this pattern hasn’t yet been fully formed but those who talk of a head-and-shoulder top say so because of the need for a correction/consolidation of the 35% increase from March 9 (remember, long ago, in days of yore, a 35% increase over two years rather than two months, would have been considered a fabulous and rare bull market).
Perhaps they’re right and, if so, traditional chart reading dictates that the neckline represents the midpoint between the top of the head and the bottom of the correction move (or a bottom of 892/944 x 892 = 843). Hence the often quoted number of 850 as the target of a downside move (a number also thrown out, coincidentally, by those who measure Fibonacci lines).
On the other hand, I’m a longer-term trend trader. Rather than seeing something negative in the above chart, I see something quite the opposite. If it comes about, I see the move down as the right shoulder of another head-and-shoulder pattern, one that’s inverse (upside down):
Of course, I’m partial to my interpretation because I have more opportunities to be correct. There’s no clear-cut requirement is for a right shoulder. The preference, of course, is to have it match in time and scale the left shoulder. But (and this is what it now looks to me like) it can turn out to be shorter and shallower due to the strength of the market driven by the sidelines money waiting to be invested.
I’m also partial to mine because it’s within a context of market momentum as measured by moving averages (and as you know, I use four). An 850 target is possible over the summer until around Labor Day and market momentum (the 180- and 90-day moving averages) would remain in tact and not violated.
One chart, two views. One sees a lack of direction and sideways movement since the beginning of May, the other sees a lack of direction and sideways movement since last October. And I’m sure each of you could see a host of other possible future outcomes. But that’s what makes the market so challenging ….. and fun (when it stops being fun, like last year, I stop playing, take my marbles and go home).
What strategy conforms to the longer-term view? Because the market is still risky in the short run so it’s to continue sitting on the sidelines, waiting for the market’s next phase to begin (when it crosses above my neckline). When that happens, it will be time to jump in with both feet and not be overly concerned about world coming to an end.