June 30th, 2009

Half-Full or Half-Empty Views: A Head and Shoulder Market Top?

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.

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  • Anonymous

    GURU-Just read the Rolling Stone article on Goldman Sachs by Matt Taibbi..Appears Goldman Sachs plans to make a lot of money on the $1 trillion carbon markets trading through several diff funds they have in place.Can you advise if the private investor can get in on this by way of stocks or funds ??Buying Goldman stock is a little too expensive for me.Thanks for any info from you or other posters.

  • Anonymous

    Interesting…

    Half-Full or Half-Empty? It really depends on how thirsty you are.

    Those investors who are thirsty (ie: Traders or Investors who are using capital they'll likely need to live on) will likely see the glass as half empty. They think, "here come the Bears!" and they get the hell out of dodge.

    Those investors who are satiated (ie: Long term investors, the extremely wealthy, or those that are not that heavily weighted in the market) will tend to see the glass as half full. They think, "markets go up, markets go down…eventually we'll go back up."

    Just a thought.

    Steve K. in L.A.

  • Jonathan

    Thanks Guru for your analysis.

    I totally agree with you on the fact that we absolutely need to be as objective as possible even though we may have positions in.

    Maybe some of the guys are short and WANT a correction. The other LONG guys will find arguments as well.

    I'm more in favor of an inverted head-and-shoulder pattern. The right shoulder will definitely be shorter than the left. That thing wants to go up.

    I did see an inverted head-and-shoulder pattern a long long time ago (see on my blog: http://guillouj.blogspot.com), however i thought about a reversal way lower than that, i was definitiely surprised by the power of that bull move. There is more to come with all that money printing.

    Cheers.
    Jonathan

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