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 Tickerville.com. His chart analysis cites the 1987 market crash (around Black Monday that wiped out 20%).

Will Shanghai Lead the Way ... to the Downside?

Well. Calling S&P500 to 1300-something was such a wonderful timing, wasn't it? While it could still get there, the timing is anyone's guess at this point, with the European "nuclear" option to save euro lasted 12 hours.

In the meantime, I was reading an article at Bloomberg, which said "China is entering a bear market". WHAT?

Shanghai Composite Index lead the way to the upside; it bottomed in October 2009, nearly 6 months before the US stock market bottomed in March 2009.


To my surprise, I found out that Shanghai totally underperformed Dow. I don't regularly check Chinese indices, but all the news about China being the engine to pull the world out of the recession has given me the impression that the stock market there is booming as well. But no. Shanghai index retraced barely above 38.2% Fibonacci retracement, while Dow touched 61.8%. Shanghai was going sideways since August last year, forming a symmetrical triangle. But instead of breaking in the direction of the previous trend (which was up), it broke down. Technical indicators (Aroon, Slow stochastics, histogram) are all negative, and already flashed a sell signal.

Dow hasn't reached that stage yet, as you see. Technical indicators are still in a bullish territory, although the MACD histogram has been one big negative divergence ever since March 2009. However, with the last week's freefall thanks to algo bots and with "we will do whatever it takes" Europe, it feels like the floor has been yanked from under our feet. And what we saw that day under our feet was a void, a blackhole.

Those algo bots were busy all day Friday and all day today to prove (to the regulatory authorities) that they are worthy provider of liquidity, capable of supporting the market. I wonder if they were successful in convincing investors. The stock market doesn't feel like a pricing mechanism any more.

Will Three Black Crows End the Rally?

What often kills a market rally is not financial in nature. It's political.

There lies the limit of TA (technical analysis), I think. Many TA enthusiasts say "It is all in the charts", but how could a chart predict, for example, the president's (seemingly) sudden declaration of war against "evil bankers", targeting proprietary trading and investment strategy? The news was leaked on Wednesday, with his press conference on Thursday, and was followed up by his townhall meeting speech (does he think he is still a candidate running for presidency?). For all these three days, the stock market in the U.S. tanked, taking the global markets along with it.

Obama's newly-found populist stance has cost the investors around the world billions of dollars in a very short time.

What comes to my mind, though, is a chatter on financial TV programs on Friday last week that Tuesday (Jan 19) would be a bloodbath. It seems, in retrospect, some traders had had some information beforehand. To the extend that these traders may have acted accordingly and thus altered the patterns of squiggles or candlesticks on the stock charts, then you could say "it's all in the chart". But that's nothing but traders trading on insider information.

Three heavy down days created an extremely bearish candlestick pattern called "Three Black Crows", which is best formed on Dow Jones Industrial Average daily. The daily chart also shows negative divergence that has been developing on RSI and CCI (at 133 for longer term trend). CCI dipped sharply below 100, almost for the first time since July 2009.

If the fourth day, Monday, is another down day, the likelihood of the market going even lower is high.

To me, the market has started to feel like a repeat of October 2008. Back then, the heavy sell-off was triggered by the passage of bank bailout bill (a political event). It was ironic, because up to that point the sales pitch for the bill to the masses had been "If we don't pass it, the market will tank, the credit will be frozen, it will be a disaster!" That disaster happened after the bill was passed.

The market was sold off for 7 trading days, shedding over 20%.

Back then, the first three trading days resulted in over 8% loss. This week, from Wednesday to Friday, the market lost 4.6%. The loss is milder this time, but September 2008 was not an uneventful month - Lehman Brothers' bankruptcy, Fannie and Freddie and AIG practically nationalized, run on the money market funds.

This is a Dow weekly chart with Fibonacci retracement lines between several tops and bottoms. Where it is at, Dow doesn't have much support until it comes down to 9,700 area. 10,000 is a support in a psychological sense, and if that breaks, it could go down very rapidly. More solid support is around 9,100, and that's July 2009 level. To be sure, negative divergence has been developing on technical indicators, as clearly seen in MACD Histogram.

For now, Dow futures are up 44 points.