Friday, November 5, 2010

Looking at the Other Shoulder & 2004

This is an often talked about pricing pattern on the S&P 500 for the long run. It is argued that we are forming a massive head & shoulders topping pattern. While the pattern does look promising, a break well above this year's high raises questions about whether or not it's valid. That's why the next few weeks are incredibly important. Nevertheless, we can still glean some important information about what the market could do by investigating the price action of the other shoulder, as well as the often talked about comparison between now and 2004 -- the beginning of the other Fed-generated bull market. I see similarities between now and 1998, as well as similarities between now and 2004.


Let's zoom in on 1998. It looks like once the new highs were achieved, the market "celebrated" by taking profits, and the market fell 40 handles, only to recover from that drop. That's consistent with the topping indicators shown by sentimenttrader.com. This is 1998, the key similarities being the big rally to a high, a crash-like moment, and a recovery.


In 2004, there were some other similarities. The market consolidation differs from the current period, but the recovery off the big market pull-back looks very similar. It marched up for about 30 handles, and then also digested those gains with a 40 handle drop after back-testing the breakout.


I can't say for sure whether or not these analogies will hold. I do feel pretty strongly that we're at a key point in the market. If this is part of a right shoulder to a massive topping pattern, you should see this breakout fail in a big way. Regardless, past history shows these new highs will probably be digested with at least a 40 handle pull-back, but in the case of 2004, it could see another 30 handles higher before dropping. I'd personally wait for NYMO to point down before considering a short position.

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