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Sunday, 1 September 2013

Cave Taurus

The aim of the technical analyst, as I see it, is to discern at the time what will be obvious to the educated eye in hindsight. For me this requires keeping an open mind and being ready to discard or promote pattern scenarios, without sentimentality or bias, as price action confirms or undermines those scenarios. By the end of a move the structure has generally become obvious, but the earlier that structure can be identified the bigger the advantage gained in trading it.

Shortly after the 1709 SPX high I highlighted the importance of the rising support trendline from 1343 both as support and in terms of determining the current pattern structure options from that low. I've been reiterating that often since then and mentioning that a break below this trendline should determine whether SPX is still in a topping or consolidation move from that 1343 low, and would eliminate at a stroke a series of more bullish pattern options from the 1560 low.

That trendline Rubicon has not yet been crossed, and while that remains the case, there are some strong short term and possibly longer term bullish options that I will lay out today, bolstered somewhat by Tuesday being the first and therefore most bullish trading day of the month, and Obama's decision this weekend to delay any strike in Syria for a couple of weeks while he seeks the approval for the military strike in Congress that he hasn't yet found in the UN Security Council.

On the daily chart rising support from 1343 was tested twice last week and held. SPX has also closed twice now well above the daily lower bollinger band, and while that remains the case the upside targets opened up by that are the 50 DMA, now at 1660, and the daily middle bollinger band, now at 1666. There is clear positive divergence on the daily RSI 5, which has been a good guide for reversals over the last year, though if rising support from 1343 should break next week, that would greatly weaken that divergence. SPX daily chart:
On the short term charts there were two obvious possible double bottoms in play at the close on Friday. The first has a target at 1643.55 on a clear break over 1635.80, and the second has a target at 1665.35 on a clear break over 1646.61. This is the setup for what could be a face-ripper rally into the SPX daily middle bollinger band over the next few trading days. SPX 5min chart:
I've talked before about how all primary bull trends on equities, and many or most bull and bear trending patterns of any degree, form one of the three main trending patterns, which are wedges, channels, or broadening wedges (also called megaphones). I'd refer you to a book demonstrating that but I haven't written it yet. In the meantime the second post in my Brave New World Series covered that on SPX and you can see that here.

The working pattern I've been using on SPX for this decline has been a declining channel, but not a strong one as the trendline hits aren't as precise as I like, and SPX failed to hit channel support last week when the much better quality declining channel on Dow did hit channel support. As long as rising support from 1343 holds, I'd like to put forward a scenario where the decline would instead now bounce from broadening descending wedge (aka falling megaphone) support.

In this scenario we would now see a bounce to test falling megaphone resistance in the area of the possible IHS neckline at the 1669.51 high. As there is a possible W bottom in place already SPX could break up directly from there and if so that would invite a test of the 1709.67 high. More likely though I would expect a reversal there towards the 1640 area where the bull scenario would see a break back up to complete the IHS and break the megaphone before breaking up towards the a test of the 1709.67 high. The bear scenario would see a continuation to break through rising support from 1343 (by then) in the 1628-32 area towards a test of falling megaphone support in the 1560-80 area.

Of these three scenarios the first two would most likely signal resumption of a bull trend from 1560 with my main target at 1965 sometime in 2014/5, as detailed in the Brave New World post linked above, and of those two I would prefer the IHS option. The third option would target the 200 DMA and it's worth noting here that in the last fifty years the only full calendar year that has passed without a test of the 200 day moving average was in 1989. The 200 DMA is currently at 1560.50, very close to the June low at 1560, and the weekly lower bollinger band currently at 1563, so if rising support from 1343 should break that target cluster will look very attractive. That area is also the trigger level for a possible primary double top targeting the 1410 area, but if reached within a falling megaphone it should be remembered that Bulkowski has these breaking up 55% of the time, and in my research on SPX only I would have these breaking up on SPX closer to 65% of time. SPX 60min chart:
For those without any knowledge of Latin or the inclination to use Google Translate today, Cave Taurus means Beware of the Bull. Given the current technical setup, and given that the first trading day of the month is on average by far the strongest day of the month, and also given that military strikes in Syria have been postponed for at least two weeks and perhaps indefinitely, the prospects for a strong rally next week are looking pretty good here, and bears should be very wary of that, even if that might well be only a strong counter-trend rally before the next decline.

TECHNICAL NOTE: I've been giving some though to broadening wedges recently, and as I said, they are one of the three main trending patterns on SPX and one of the commonest patterns on any chart. They may have been first identified by one of my TA heroes Bulkowski, though he isn't certain of that, but in my view Bulkowski has not appreciated the importance and frequency of these patterns, and has given them in consequence an irritatingly overlong and unwieldy name. I'm going to add a glossary to my blog with definitions and links for the patterns I write about and show, giving me some ability to rename existing patterns and add new ones, and from now on I'm going to call these broadening wedges rising and falling megaphones, to fit with those other main trending patterns rising and falling wedges. I'm also going to describe channels as rising and falling (rather than declining) channels to make the names of all these three main patterns consistent in future.

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