September 2nd, 2010

Cooking Up An Inverse Head and Shoulder Reversal

After posting the following, I got to thinking. I say below that I will be adding to long positions and reducing cash as the market proves itself and continues successfully moving to ever higher levels. A break above 1128 and I could be fully invested.

But that flies in the face of those who are bearish about this market. They’re strategy would, instead, welcome every upside move as an opportunity to sell stocks at higher prices than they ever hoped they could and that by the time the market touches the upper end of the trading range (however, that may be defined) they intend to be 100% in cash.

It’s the old strategic choice between buying at the bottom of a range/selling at the top and waiting for a break above a range before buying. But this time it’s played out on the larger stage of market timing. I’d be interested knowing what your view is?

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What can I say without it sounding too much like I’m bragging. The market performed beautifully yesterday (if your one of those leaning to the bullish side of this boat we’re floundering in) and seems to have followed through today.

Having said that, there isn’t enough evidence yet to jump in with both feet. With the market closed Monday for Labor Day, at 1090 the market is just barely above the converged 50- and 300-dma’s. Another 3.5% move up above 1128 and the market would cross what I’ve indicated to be the neckline of an inverted head and shoulders pattern. Each advance causes me to move even closer to a 100% invested position (click on image to enlarge).

I know I’m going to be criticized yet again for being too optimistic or pallyannaish but I’m looking forward to the possibility …. now perhaps 60/40% …. that the market also will hit and cross above the major, long-term descending trendline that stretches all the way back to October 2007. Granted, yesterday I took you through the risks inherent in upward-sloping trendlines so I’m well aware and prepared that after a crossover, should it happen in the first place, there will probably also be a retreat back to the trendline to test its strength as support and, in the process, generate another downward sloping trendline to replace the current one.

In “Climbing Out of the Boxes With REITs” of July 27, I included 3 residential REIT charts – SNH, AEC and HME. Each has down well since then. There are many other REITs breaking out of well-formed consolidations:

  • EDR (Education Realty)
  • SUI (Sun Communities)
  • EQR (Equity Residential)
  • ACC (American Campus Communities)
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  • Anonymous

    Joe or anyone,,advise some good stock mining newsletters out there ? Thanks for any info.

  • lo574

    Joe I think many of us are questioning true direction of the market at this juncture however a trader friend of mine had months ago recommended using a 5month SMA/13month EMA to determine direction bull or bear; which we are perilously close to at this point.

    While I haven't been able to locate his research [like xmas presents – put it somewhere don't recall where], I would like your feedback.

    I enjoy your blog and have referred it to many. Keep up the very entertaining and enlightening banter.

  • Joe

    The 5mos SMA/13mos EMA is close to 100day SMA/250 day EMA since the average month has 20 trading days. I use 50/100/200 and 300day SMAs for my indicators on market direction. Using two MAs is a simple cross over (or MACD) indicator. I prefer using 4 MAs instead of two because it gives me a better sense of that rate at which momentum is changing direction.

    I am perplexed, however, of combining SMA and EMA. I don't like EMAs because they give more emphasis to near-term market levels than distant. Combining a 100SMA with a 250EMA is double counting, or emphasizing, levels within the last past 100 days as compared with levels more than 100days ago.

  • Douglas

    The problem with analyzing stock trends is that you can read anything you want into them, and the final analysis is biased towards the analyzer's initial position. For instance, you could read the charts as an inverse head and shoulder as you have, with the head at the early July low of 1020. Then again, you could read an upright head and shoulder with the head at the early Aug high of 1130 (shoulders at 1100 in mid July and mid Aug). What troubles me most, however, is the trading volumes. All upward surges (including the long one last Fall) have come on much lower trading volumes than the downward moves. The highest volumes all occurred on down 2-3% moves in a single day. I think that many traders are trying to recover from the crash too quickly, so when the economy shows the weakness that actually is, the "hopes for a better tomorrow" become the "reality of the current slow recovery." Until GDP levels return without the help of government stimulus, I expect that the bull-bear battle continues with further sideways movement.

  • Anonymous

    EEM is leading SPX