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Thursday, 14 June 2012

Bullish Reversal Patterns

Of the many forecasting tools that can be used to predict the future using the past, possibly the worst is extrapolation, though it is probably also the most widely used. Extrapolation is a process of rationalising that whatever has been happening recently has been for strong fundamental reasons, and will therefore continue, and it is extrapolation that makes people buy at highs and sell at lows. 

Possibly the most famous person to forecast mainly, or possibly only, using extrapolation was Alan Greenspan, who in my view was one of the worst central bankers in history as a result. He made a number of famous strong calls in the 1970s and 1980s forecasting major continuations at big highs and lows, and it was these calls that led to Senator Proxmire describing his forecasting record as the worst that he had ever seen at Greenspan's confirmation hearing in 1987. Did he learn from his mistakes then? Well .... no, and it was Greenspan using his abysmal forecasting skills to direct the US economy that led to two of the largest speculative bubbles in history, and the consequent hangover that the world is likely to be suffering through for quite a while longer. 

How does this relate to what we are looking at today? Well, we have seen a very significant correction from the highs and many are looking for that to continue from here. They might be right, but the technical picture on equities is increasingly suggesting that they have put in an interim low, and possibly a major low, though I think that's currently less likely. I'll devote today's post to looking at those bullish reversal patterns forming on equities at the moment. 

Before I get to that let's have a look at yesterday's action on SPX. On the SPY daily chart you can see that the middle bollinger band was support for the fifth day running. That is clearly immediate support and it's possible that it may continue to hold:
In the short term there are two clear H&S patterns forming on SPX still. If the bearish H&S with a target at 1275 SPX continues to form then I would expect a test of the neckline at 1308 today or at latest tomorrow morning, as anything later would damage the symmetry of the pattern. For the much larger bullish IHS that is forming, symmetry suggests that the right shoulder will take two to four days more to form, with the low in the early to mid-1290s. I've added a possible rising channel support trendline as possible support:
On to the bullish reversal setup on equities. The first is on SPX where I've been posting the falling wedge that broke up last week as well as the IHS that is forming. This bullish setup, as with all the other equity index charts that follow, is strengthened by positive RSI divergence on the daily chart at the current lows:
Next is NDX, where there is a clear IHS forming with a target in the 2700 area:
Next is RUT, where an IHS is forming at the neckline of the H&S that formed February to May, and that has a target in the 825-30 area:
The broadest US equity index is the Wilshire 5000, where a downsloping IHS is forming with a target in the 14750 area:
World equity markets have been much weaker generally than US markets over the couple of months and also the last year. On the MSWorld index, which is the world equity index excluding the US, the IHS forming there targets the 1445 area, which would be a rally that would take it close to a test of declining resistance from April:
Of major world equity markets I've picked FTSE to post today, as there's a very nice W bottom formed there at the lows, and which has already broken up with a target in the 5630 area. That would also set up a test of declining (possibly broadening descending wedge) resistance there:
How would a strong rally here affect the much larger bearish patterns forming on many indices and instruments across the world? I don't think it would affect them much at all, and I'd therefore still be leaning bearish after that strong rally unless we saw significant resistance breaks on those world markets. In the meantime this is a strong bullish reversal setup, and I would suggest caution shorting into this. If I had to pick an analog for what I'm seeing here, I'd be looking first at the IHS that formed in summer 2010. 

That said, these bullish setups may fail, and if they do, the decline afterwards may be a large one, as failed reversal patterns are characteristic of very strong trends. 

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