Great Graphic: Head and Shoulders in S&P 500 ?

The S&P 500 appears to have traced out a head and shoulders topping pattern. This Great Graphic was created on Bloomberg. The left shoulder was put in place in the third week of July. The head was in early August and the right should was carved out earlier this week.

The importance of technical patterns lies in their measuring objective. The measuring objective of a head and shoulders pattern is the distance from the head to the neckline (the red line) flipped over (the green line). It projects toward 1650. Technicians regard this as a minimum objective.

The fact that the S&P 500 gapped through the neckline lends credence to the pattern. There are different types of gaps (and I review them here).  If this is a normal gap, one would expect it to be filled over the next few days.  If it is a measuring gap, which takes place about half way through a move, it would also project toward 1650.  A break away gap is the most significant as it suggests the beginning of a move.  

The S&P 500 rallied about 9.5% off the June 24 low through the record high earlier this month.  The 38.2% retracement of this advance is near 1652.  Of interest, the 50% retracement is found near 1635 and the 61.8% retracement is near 1617. 

In addition, we note that the 5 and 20-day moving average crosses have provided reasonably good signals this year (bullish when the 5-day is above the 20-day and vice versa); catching the big moves this year, with minimal whipsawing.   The 5-day moving average crossed below the 20-day moving average on Tuesday, August 13. 

There are some technical indicators that favor caution.  First, the price objectives are approximate and not precise.  Today's low near 1656 might be close enough to the targets.  Second, while we recognize that the returns (price changes) are not normally distributed, which calls into question measures like standard deviations, we note that rarely, as in three previous occasions this year, has the S&P 500 moved below the lower Bollinger Band set at 2 standard deviations below the 20-day moving average.  That lower band comes in near 1666 today.  Each time this year that the S&P 500 closed below the lower Bollinger Band, it was, in hindsight, a buying opportunity. 

Great Graphic: Head and Shoulders in S&P 500 ? Great Graphic:  Head and Shoulders in S&P 500 ?  Reviewed by Marc Chandler on August 16, 2013 Rating: 5
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