2-8-16 Comments

We have now closed below a possible neckline of a head and shoulders pattern on the NASDAQ. Other indices such as the small caps and the DOW transportation index have long ago broken down and completed their patterns. Completed Head and shoulders patterns can sometimes lead to useful market price targets. The technique measures the extension of the possible top above a neckline and extends the same distance price below the location where the price breaks the neckline on the right side of the pattern. Below, in the chart are possible constructions, I have an ambiguity as to which left shoulder low to select, thus the optimistic and pessimistic projections. As I look at the chart I remember something from a Richard Arms book (Profits in Volume) written in 1971, he wrote: "...volume leads to volume. The volume that is generated in the building of a base is almost exactly the volume dissipated in the ensuing advance. Similarly, the volume occurring in a top formation is very close to the same as the volume involved in the subsequent decline." I consider the topping formation in the chart a large structure containing a considerable quantity of volume, more than one year of trading. From the foregoing, my expectation of an early end to a market sell-off is limited. You can see the price projections of a total decline off of the top of 34.6% to 38.5%. This technique applied to the 2002 bear market nailed the bottom. The method was optimistic for the 2009 panic bottom by about 10% but did accurately pick a price support region of that sell-off.

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One thing that I note that agrees with Pascals comments for this morning, short selling right now may be problematic. Necklines are exactly where bear market rallies can begin. One caveat to this observation, we have already broken the neckline two weeks ago and staged a weak rally. Is that all that this market can bring to the table? I don't know, but I note a gap down is setting up this morning.

Watch lists are updated. IBD has placed the market uptrend under pressure. The MarketSchool model exposure is 100% cash. Trading in these volatile conditions is problematic and a risky place for a medium-to-long-term investor to be.

I have a fairly repeatable method of creating watch lists. When the number of stocks on a watch list drops to a small number, it is telling me something about the market. Only two items survived the long list. Two data points from Bill O'Neil are that leading stocks drop in price by 70% on average after a market top and that only 1 out of 7 stocks leads in subsequent bull markets. This may not be the time to be a long-term investor holding onto your favorite stock.

For me, I am taking on-line classes with MatLab, a mathematical and programming tool instead of trying to catch a bounce. When the watch lists I produce have quality stocks setting up in constructive patterns I will become more interested. For now, my watchlists are my viewport to gauging a possible market direction change and not necessarily a shopping list.