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Three Strikes For The NASDAQ?

06/27/07 02:49:10 PM
by Gary Grosschadl

When a stock or index is overextended, it can suddenly correct at the first candlestick warning or defy gravity a while longer.

Security:   $COMPQ
Position:   Sell

This daily chart of the high-tech index shows three bearish candlestick formations (Figure 1). The first bearish engulfing pattern was quickly forgiven — call it strike 1. The second warning (strike 2) came as a doji candlestick; after an extended rise, dojis often mark a pending reversal. This one only precipitated three down days.

Now another bearish engulfing candlestick has appeared, bigger and uglier than the first one. This third warning could be strike 3. Three warnings will not go unnoticed; call me superstitious, but technical analysis is rife with patterns involving threes — triple tops & bottoms, head & shoulders, three white soldiers, three black crows, and so on.

Multiple negative divergences (three of them) often point at a run being overextended and due for a correction. The moving average convergence/divergence (MACD), the relative strength index (RSI), and the Chaikin money flow indicator (MF) all show diverging action. As the index makes new highs, these indicators fail to confirm the bullish price action. This is certainly a bearish indication, but the question will be: When and how much?

FIGURE 1: NASDAQ, DAILY. The chart hints at three strikes via bearish candlestick formations.
Graphic provided by:
Note the previous good support from the 50-day exponential moving average (EMA). A close under this level could be the final nail in this coffin. Moving averages often are likened to natural trendlines. A support trendline drawn would closely match this EMA.
Should a sizable correction occur, look to the always important 200-day EMA as a likely downside target or test; note the previous successful test of the 200-day EMA last May.

In summary, this index has warned three times of a possible top. The bulls are starting to waiver, say the indicators. The umpire is watching the 50-day EMA, and failure there could be a run south to stronger support. Time will tell soon enough.

Gary Grosschadl

Independent Canadian equities trader and technical analyst based in Peterborough
Ontario, Canada.

E-mail address:

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