Saturday, May 22, 2010

Will Market Topping Pattern Repeat?

I'm afraid it may.

In the last post, I mentioned the expanding wedge on the Dow daily chart and technical indicators at the critical levels on the weekly chart. That was May 19. The next day Dow took a dive over 370 points blasting through 200-DMA. Friday's bounce caused by short covering algo bots failed to go anywhere near the 200-DMA.

Yes, the candle formation on Friday is a 'hammer', and may actually bounce as algo bots are getting smarter and smarter in giving us an illusion that the 'market', an exchange of price information about the health and potential of companies and business sectors, still exists.

But so what? Friday action didn't convince me a bit that the bearish trend is over. On the contrary.

Take a look at this Dow weekly chart from 2007-2008, which captures the market top.

And take a look at the current Dow weekly chart. My comments are on the charts.

In 2007-2008 market top, the whole pattern - head and shoulders pattern with a failure to capture the trendline from head to right shoulder, and a failure to capture the neckline as well as 40-MA - took roughly 12 months. The head and shoulders pattern itself took 8 months, and the failure to capture the key area took another 6.

This time, we already have a left shoulder and a head on the weekly. Right shoulder looks yet to form. From the beginning of the left shoulder, it has been 7 months.

Also note that in the 2007-2008 market topping pattern, the weekly candles had long body and long wicks, indicating increasing volatility. We are already seeing them almost every day on the current daily chart, and they've started to show up in the weekly chart.

It is possible that the index suddenly musters strength and negate this nascent head and shoulders pattern. Personally, I wouldn't put my bet on that possibility.

It is also possible that the index will keep on collapsing from here. Ease with which the 200-DMA was breached on the daily should be disconcerting for the market bulls (particularly those on a certain financial show on a certain network, giddy with euphoria that the market 'turned' on Friday).

No need to panic like a chicken with the head cut off (like European politicians) as we have seen the pattern in our recent past, but no need to be a stock trading hero either. For once in a very, very long time, I agree with Q-man (Quint Tatro) at His chart analysis cites the 1987 market crash (around Black Monday that wiped out 20%).

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