Too Much to Analyze

For the past couple of days market has been going sideways. Today's market action saw a very sharp decline in the VIX. This behavior might be positive in the short-term, but it definitely is not good for the long-terms prospects of the stock market. Sharp drop suggests that people were complacent through out today's trading, which does not bode well for the market. Overall, it seems like the market needs further sideways action to overcome the near-term oversold condition, and to complete the correction pattern needed before the next decline phase.


As I was reading through the news, pursuing through the charts, and analyzing the economic data, I came across multiple interesting topics to write about. These topics will be addressed over the next few weeks:

1. Copper: Is the chart showing an economic cliff?
2. Emerging Markets: Is the chart showing another credit crises brewing?
3. Global Stock Market Index: When will we get out of the 1.5 year bear market?
4. Gold: New highs in store?
5. Oil: Breakout or Breakdown?
6. Implications of Presidential Elections on the Stock Market: The Conclusion!!
7. AAPL: The Curious Case of Social Mood
8. Housing Market: Recovery Complete? Get ready for the next leg down?
9. Consulting Endeavours: Discussion of small business / small business investment analysis performed for clients. This discussion will help the blog readers in making educated business decisions.

Among all of the above topics, I will start with the concept of Head and Shoulders. And will use it as a segway into topics 1, 2, and 3.

HEAD & SHOULDERS TOP
 

The Head & Shoulders (H&S) formation consists of a left shoulder, a head, and a right shoulder and a line drawn as the neckline. It typically indicates a trend change. We have experienced several H&S completed at various degrees of trends prior to major tops, such as 2007 top, 2000 top etc.

The left shoulder is formed at the end of an extensive move during which volume is noticeably high.
After the peak of the left shoulder is formed, there is a subsequent reaction and prices slide down to a certain extent which generally occurs on low volume.

The prices rally up to form the head with normal or heavy volume and subsequent reaction downward is accompanied with lesser volume.

The right shoulder is formed when prices move up again but remain below the central peak called the Head and fall down nearly equal to the first valley between the left shoulder and the head or at least below the peak of the left shoulder. Volume is lesser in the right shoulder formation compared to the left shoulder and the head formation.

A neckline is drawn across the bottoms of the left shoulder, the head and the right shoulder. When prices break through this neckline and keep on falling after forming the right shoulder, it is the ultimate confirmation of the completion of the Head and Shoulders Top formation. H&S necklines can be down sloping or up sloping, depending to the severity of the trend.

Neckline Break: The head and shoulders pattern is not complete and the uptrend is not reversed until neckline support is broken. Ideally, this should also occur in a convincing manner, with a high increase in volume.

Support Turned Resistance: Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly not always, the price will return to the support break, and offer a second chance to sell.

Price Target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. This distance is then subtracted from the neckline to reach a price target. Any price target should serve as a rough guide.

HEAD & SHOULDERS - THE REALITY

• All H&S patterns do not result in sharp declines. If a pattern is shorter in duration, it might just be a continuation pattern. On the other hand, if the pattern is longer in duration, it would suggest a market top is at hand.

• H&S patterns graphically portray the distribution that takes place at market tops, from stronger hands to weaker hands. Throughout this pattern, prices remain in a tight range because both buyers and sellers fight out for the true price of the asset. Typically, people who owned the stock since the bottom want to sell their positions and lock in profits. Whereas, those who initially missed the boat want to buy in. Soon thereafter, all the buyers are exhausted from the market place and only sellers remain. This lack of demand pushes the market down to the next level of support because the volume needed to drive the stock prices higher is absent. As a result, the right shoulder is usually lower than the head. Finally, when the market comes back to the neckline for the 3rd time in the right shoulder, it breaks below the neckline. This break often results in a sharp decline of prices.

In the next article we will be analyzing the impact of the H&S formation in the Copper chart (as of today) and its probable consequences on the global economy.

SUBSCRIPTION INFORMATION

If interested in these updates, please fill out the form below.