Technical Analysis 101: Head & Shoulders Pattern
Although I know I'm going to take heat here from the naysayers of technical analysis, the Elliot Wave Theorists, and frankly anyone else here who doesnt like me, I'm calling the S&P firmly in the throws of a head and shoulder top.
A head and shoulders pattern is purely technical, as I've displayed below, whereby you have a move higher then lower (the left shoulder). This first move will set the relative value for your neckline (the level at which your moves lower will generally bounce). After this first move you get an even larger thrust higher which equally results in a move generally right on or very very close back down to the neckline; we call this the head. Finally, the last move higher is met by resistance at nearly the same level as the where the first shoulder stalled. What generally happens is the ultimate test of strength at the neckline. If the chart can hold within reason, say 2% of the neckline, the technical strength remains bullish. However, if the stock price falls decisively below the neckline on this final move, historical momentum has shown that the retracement value is generally the distance measured from the neckline to the average closing highs of the head.
Do I have figures to back this up? Well yes, but do I remember where the hell I read them, no =) From the last that I remember, head and shoulder patterns are the most accurate charting indicators. I believe that they correctly predicted the movement of a stock just a hair over 70% of the time. So more or less, a head and shoulder pattern on paper is accurately predicting a falling stock price 7 out of 10 times. (By the way, for all you perma-bears, keep in mind that reverse head and shoulder patterns exist so they are incredibly bullish).
More evidence needed? Well, from my holy grail of Technical Analysis, Edwards and McGee's "The Technical Analysis of Stock Trends" c.1964, the authors mention that head and shoulder patterns often see stronger volume on the first shoulder, then weakening volume on the head and even weaker volume on the final shoulder. If you look at the illustrated chart above, tell me if you notice a trend in the volume? Giving you goose bumps isnt it?
So what does this mean for the S&P? I think sometime this week we are going to run into some big problems between 928-933. If we break this mini-channel we're in ( about 913 or lower would do it ) we are almost assuredly going to re-test the neckline. These head and shoulder patterns tend to be fairly symmetrical in their nature but admittedly moves to the downside tend to be much more swift than moves to the upside. Downside pressure, taking into account the neckline at roughly 878 and the head at 954, should mathematically put us at 806 on the S&P within 5-6 weeks. I've been calling for 808 as my retracement level for about 5 weeks now and I'm going to stick with that level. Everything including my gut, the daily news and the charts points toward a retracement to 808 on the S&P.
Call me nuts... I know