Friday, 6 June 2008

:: Market WrapUp: Market Continues to Trade Multiple Head and Shoulders Reversal
ozymandius Donating Member (1000+ posts) Click to send private message to this author Click to view this author's profile Click to add this author to your buddy list Click to add this author to your Ignore list Fri Jun-06-08 10:31 AM
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1. Market WrapUp: Market Continues to Trade Multiple Head and Shoulders Reversal
(With an Ominous Exception)

A logical pattern that fits the behavior of the S&P 500 is that of the multiple head and shoulders (HAS) reversal pattern. This article references the characteristics of the pattern as described in Technical Analysis of Stock Trends by Edwards and Magee, a book that should be a cornerstone of a technical analyst's library. As stated on page 75 of the 8th edition, these selected quotes help to describe the multiple head and shoulders reversal (emphasis added by Martin),

“(multiple head and shoulders) patterns may be described quite sufficiently as Head-and-Shoulders Reversals is which either the shoulders or head, or both, have been double or proliferated into several distinct waves…

...They appear with fair frequency at Primary Bottoms and Tops, but more often at Bottoms than Tops. They appear less frequently at Intermediate Reversals.

...Still another, of which you will usually find several good examples at any Major Market Turn, consists of double shoulders on either side of a head which is itself composed of a small but quite distinguishable Head-and-Shoulders development.

...We have mentioned the tendency toward symmetry in the simple Head-and-Shoulders Formation. Patterns of the Multiple or Complex type show an even stronger urge toward symmetry – so strong, in fact, that it may be counted on in determining trading policy. If there are two shoulders on the left, there will almost always be two on the right of nearly the same size and formation until the right shoulder becomes evident. (Of course, one does not know that a Multiple is in the process of formation until the right shoulder becomes evident.) Except for volume, the right-hand half of the pattern is, in the great majority of cases, an approximate mirror image of the left.

...Up-sloping and down-sloping variants seldom appear in this class of patterns; necklines are almost always very close to the horizontal.

Below is the proposed multiple Head-and-Shoulders pattern depicted in the weekly chart in early December. At that time, the pattern could only have been proposed since it had not yet been completed. The gray line in the chart below depicted the general price action that would have occurred in the future if the pattern were to remain valid. Volume guidelines are also shown in the chart. The forward price and volume action were based on the characteristics described by Edwards and Magee – including one head and two shoulders, symmetry, volume patterns, and horizontal necklines. Since the pattern had not been completed, it was a relevant question to ask the basis for suggesting this pattern.

This would seem to suggest that if the pattern is valid, the price objective of the multiple HAS pattern will take the S&P 500 to about 1225, but not below. This conclusion would be supported by the need of the government and Fed to avoid a severe stock market correction in the face of negative economic fundamentals. If they cannot keep the stock market correction “leisurely,” the feedback loop into the US consumer and the wealth effect will have a spiraling effect back to the US stock market and in turn, back to the economy and again back to the stock market.

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