There is a potential bearish Head & Shoulders pattern developing in some of the major stock indexes. I’m sure you’ve heard about this pending pattern, that is if you’ve watched the financial news, read many blogs, or have been on twitter. You can clearly see the left should and the head already formed on the chart of the S&P 500 ETF above. There is a well defined neckline that is almost horizontal. The right shoulder is beginning to appear to be building a symmetrical shoulder to the one on the left.
The psychology of the pattern can make sense. A first impulse move is put in. Then a correction appears that finds support. Then another impulse move to new recent highs, but usually with less duration that what preceeded the pattern. Then another retest back down with the market holding near the previous support level. Then a third rally that fails to get back up to the level of the second rally, with the market usually stopping close to the level of the first rally. Finally the market again retests the support line that held twice before. Traders and investors get discouraged and begin selling, thus driving prices well below the neckline support. Bulls often rally the market back up to the area of the neckline in one final test, which usually fails. Then the market rolls over to begin a large decline.
The above paragraph is what is found in most beginning books on charting. Indeed the head and shoulds pattern, and the inverse head and shoulders pattern found at market bottoms, are eye catching when seen on past data on a price chart. The successful patterns tend to pop off the page. However, on closer inspection, many more failed pattern can be found. The eye tends to gloss over the failed patterns.
The larger question regarding this impending pattern, as well as major chart patterns in general, is if there can be an edge in trading such patterns. This particular developing pattern has been mentioned numerous times in the last week or two. I’ve heard it and seen it mentioned dozens of times already. There are more chart readers and technical analysts than ever, and they’ve all read the same books, and I would guess that every single on of them are watching this pattern. I’m not quite sure how there can possibly be an edge in what everyone sees. If a major pattern presents itself, it can become self fulfilling for a time. However, professional traders are also aware of the pattern and could be quick to fade the move. It will be truly amazing if this pattern completes itself as many expect. What everyone sees is usually wrong. There can be no edge in betting with the majority. The cycle indicator on the chart could easily roll over if the market heads back to the red neckline, but I’d be careful going with the heard at that neckline. I’ll be watching this carefully and will update as the pattern develops.
There, I got through a whole post without commenting on Al Frankin…..well, almost.