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HEAD & SHOULDERS


The S&P 500's 30-Minute Head And Shoulders Bottom

04/06/05 09:01:58 AM
by David Penn

Did somebody say "bottom"?! The head and shoulders formation in the 30-minute S&P 500 might be the bulls' best bet on an end to the March declines.

Security:   $SPX
Position:   N/A

Sometimes I wonder if you were to take a certain chart pattern out of its immediate context -- for example, by hiding the prices or the date or the name of the instrument -- would it make some patterns easier for people to trade? Charles Kirk of TheKirkReport.com did an experiment with this a few days ago, when he covered up the prices of a stock to show how different the psychology of trading a $10 stock was from the psychology of trading a $100 stock.

I don't know if the current head and shoulders bottom developing in the 30-minute chart of the cash Standard & Poor's 500 fits into this syndrome or not. If this were a daily chart of the S&P 500 instead of an intraday one, if this were a chart of one-time-highflying stocks that investors had become accustomed to seeing ramp higher, would it be any more attractive to traders?

Figure 1: S&P 500. The strange spike and reversal (that accompanied the jobs announcement for March) notwithstanding, it appears that the month-long decline in the S&P 500 may meet its match in this head and shoulders bottom.
Graphic provided by: Prophet Financial, Inc.
 
Late March volatility notwithstanding, the head and shoulders bottom is a compelling pattern for a number of reasons. First, the pattern is clear and coherent: a left shoulder begins with the sharp drop on March 22 and ends with the rally over the next few days. A decline in the March 28th-29th time frame begins the head of the pattern, a head that is completed in exuberant fashion with the rally from the end of March to April 1. From here the right shoulder of the head and shoulders bottom begins in the correction from the April 1st peak and appears to end with the Monday rally on April 4.

A second factor is the fact that bottoming/reversal pattern appears just as the S&P 500 is testing major support. A great deal has been said about the 1165 area--both here at Traders.com Advantage and throughout the technical trading community--and with good reason. Support here would almost guarantee a tradable rally to the upside. Failure here would almost guarantee a violation of the January lows and perhaps a test of the October 2004 highs near 1140.


A third factor is the positive stochastic divergence between the left shoulder and the head of the pattern. As I've said before, technical indicators can be of great assistance when looking at the viability of chart patterns and it appears as if the relationship between the 7,10 stochastic here and the head and shoulders bottom is another example of how this can work. The 7,10 stochastic makes a low at the same time that the S&P 500 does on March 23, but when the S&P goes on to make a lower low on March 29, the stochastic makes a higher low. As I wrote recently, this positive divergence is what is responsible for the sharp rally in the S&P 500 that began on March 30.

And this same positive divergence may turn out to be responsible for more than that. Rather than break out on April 5, the S&P 500 hovered and consolidated near the 1180 area--which is probably as good as anywhere to locate the neckline for the pattern. If the head and shoulders bottom is to be valid, then the S&P 500 is at a crucial level. In short, the market needs to use the Tuesday, April 5th consolidation as a launching pad to push initially beyond the 1190 area--the peak of the job announcement-related spike--before moving even higher toward its minimum price objective.


That objective? If we use 1180 as the neckline and find the lowest point of the head and shoulders bottom at about 1165, then traders should expect a rally to at least the 1195 area over the next few days.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Comments

Date: 04/07/05Rank: 5Comment: Excellent article. I learned or had explained more clearly 6 different items. The bibliography is excellent, as well. Want to look at some of those books, such as TIMING, after I complete my license examinations in the next weeks.
Date: 04/07/05Rank: 3Comment: 
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