A Head and Shoulders BOTTOM!?!?

There has been a certain amount of chatter lately re the prospects of a head and shoulders topping pattern. To the best of my knowledge, however, I am unaware of anyone who has put forth the prospects of a head and shoulders BOTTOM. So, here goes.

The accompanying chart illustrates the prospective bullish pattern with the obvious necessary future price action to make it happen. While not fitting the textbook version of the pattern, considering the heavy bearish sentiment in the air such an outcome would have to rank fairly high as a contrarian call. The measured move of the pattern is not a biggie – 100 points above the neckline, which is around 1120. That means the upside potential is limited to the approximately the previous high, which is around 1220. And that gets us into a whole other set of potential patterns. (Double tops, anyone?)

A Word of Caution

As someone who has conducted numerous events and interviews with some of the very best in technical analysis, when it comes to head and shoulders patterns there is one piece of advice each of these veterans of technical analysis cite: NEVER anticipate a head and shoulders pattern. Like a good boy scout, being prepared is always a good thing to do. Whether to act or not before the fact is risky business.

That said, acting on what others might act on can be a profitable exercise. Which brings me to the main point of this blog commentary.

If you have read my blog for any length of time you know I am not a chart pattern guy. Like investor sentiment and volume measures, I find chart patterns necessary to be aware of as so many others reference and sometimes act upon them. However, as a highly predictive tool in and of themselves, not so reliable. Therefore, as a student of the market, it is essential that I understand the market structure and the behavioral aspects of how the game is played. In other words, knowing the nature of the beast (structure and participants) should be an essential part of every investor’s investment decision-making toolkit.

Accordingly, the structure of the market (e.g. high frequency trading, the role of ETFs, dark pools and structured products and how they disguise the true nature of investor interest) and the players, their motives and behavior (e.g. hedge funds, traditional institutional investors, the virtual disappearance of individual investors) has become an essential part of the investment decision-making process. Put differently, if you are sitting at a card table and don't know who the sucker is, it's you. In all this, pattern recognition and other use such tools (that others tend to use) are most helpful when it comes to playing the game, hopefully tilting the odds more in your favor.

What About The Bounce?

By the way, the bounce potential for stocks is intact. The bottom parts of the accompanying chart show near term weakness (momentum and MACD) and a short term oversold (slow stochastics). The conclusion reached the other day is unchanged – a bounce and little more.

Whether the bounce is like a ball going down a flight of stairs, bouncing up after each progressive lower step (the reverse of most of last year’s market action) or the start of some stabilization culminating in the head and shoulders bottom remains to be seen.