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An interesting chart development in the S&P 500

Submitted by naufalsanaullah on 08/28/2010 22:57 -0400

I have been mentioning in recent pieces my opinion that Wednesday’s bounce off the S&P 1040 S/R level marked an interim cycle low and that risk would be bid in the near term. Using that assumption, an interesting pattern is developing in the chart of SPY/S&P 500.

I have written about the impending head & shoulders development in the charts on multiple occasions already, with January highs marking the left shoulder, April highs the head, and recent highs this month the right shoulder. The neckline around SPY 102 suggests a breakdown to about SPY 84-86, if the traditional head & shoulders target calculation is used.

However, another pattern is developing that is implying a similar target zone, that is a bit less voodoo-ish than head & shoulders. If this week’s lows are taken as cycle lows in the same breadth as July lows marking their cycle’s lows, then the trendline connecting these lows seems to form the support trendline of a very large symmetrical triangle that is quickly approaching its apex.

April & August highs (the head & right shoulder) connect to form the resistance trendline of the triangle, and using the triangle’s range and projected apex/breakdown level, the target implied is around 85-85, which translates to the important S&P 875 S/R level.

Triangles are unique chart patterns because they make intuitive sense. Resistance areas are where excess supply overtakes demand and price falls, whereas support zones indicate excess demand. If both resistance and support trendlines are converging, that indicates that supply is being offered at marginally lower levels (sellers getting more aggressive) while demand is being offered at marginally higher levels (buyers getting more aggressive). This type of positioning often precedes big moves, as one of the theses (bull/bear) is proven wrong and the other side of the trade (the right side between the bulls & bears) “wins” over, with the wrong thesis being liquidated and amplifying the move. Although technical analysis gets a reputation for being little more than voodoo forecasting, some of it, like well-defined triangle patterns in the indices, have a priori basis to their theses and implications. As an example, I’ve provided the symmetrical triangle in QQQQ that “called” the massive move down during and after the fall 2008 market crash.

Before (implied target of QQQQ 27):

After (actual low of just under QQQQ 25):

I am expecting a bounce from here to test the upper bound of the triangle, which corresponds well with the overhead 200d that should also provide resistance. If SPY indeed fails to break its triangle resistance/200d, I expect that test to mark a very significant top in the market and expect the next move to be the downside, breaching the triangle’s support level, and then next the 103.50 & 102 S/R zones, taking SPY down to below 90.

In the event of a triangle breakout to the upside, I expect SPY to test June & August interim highs around SPY 113 and price action from there to determine trend; continued strength through 113 should take the market much higher, while selling at 113 and subsequent 55/200d breakdowns should mark the top and precede a big move down.

OPEN TRADES

Original piece here.

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Sun, 08/29/2010 - 00:24 | 550901 IQ 145

If it doesn't go up, it'll probably go down. That's it for the technical analysis, folks. the sooner you figure this out, the less money you'll lose.

Sun, 08/29/2010 - 01:56 | 550945 Irwin Fletcher

The statement that "Triangles are unique chart patterns because they make intuitive sense," seems to support your thesis. However, unlike a lot of technical analysis, there seems to be a prediction here - at some point in the future, the SPY will approach the 200 dma, and then it'll either go up or go down. If it goes up, it'll go up by ~5%, and if down, it'll be more like 15%. Unfortunately these percentages seem like guesses.

Sun, 08/29/2010 - 02:26 | 550960 naufalsanaullah

Tech analysis isn't about making predictions. It is about providing context to your fundamental theses.

If my macro assessment of the market is that if A occurs B will happen and if C occurs D will happen but I know enough about the existing conditions to be able to limit the variables like that, then the price action and technicals of certain securities and their correlated assets can be very good to figure out if B or D is more likely to be the scenario, support your hypotheses, and more importantly turn them into tradeable theses.

Most reputable trading houses, like at bank prop desks and hedge fund trading desks (whatever you say about them, that is indeed where the world's best traders are), all use technical analysis, although to provide context to more holistic approaches and analyses, not make predictions and trading decisions.

Sun, 08/29/2010 - 02:56 | 550982 Irwin Fletcher

I don't quite see the logic behind "providing context to your fundamental theses" rather than making a prediction or a trading decision, but I don't trade for a living. Also, the article doesn't seem to provide any motivation for why B or D would be any more likely to happen than E or F. Is it simply the analogy to the 2008 QQQQ chart? Why several breaks of resistance to the downside? What creates that momentum, and what's the point of defining a resistance level if it's just going to be passed right through? Is there some relevant time frame to consider? Sorry if my skepticism is naive, but on the surface the analysis seems hard to believe. There's a lot of TA presented here on ZH, and I know that the best traders use it for certain securities, commodities, etc., and that the tricks are different in each market. It certainly seems that it must be useful for something, but astrology also seemed that way once.

Sun, 08/29/2010 - 03:15 | 550993 naufalsanaullah

Every trade has a thesis, and the stronger the justification, the better the trade. The context that it provides is that it explains to you which thesis the market is running with and that provides inputs for other trading decision outputs.

When I see a consolidation pattern develop it spells uncertainty and choppiness to me, especially if volume is high on both ends and volatility increases. The direction the market takes from that consolidation, confirmed by volume and price action, provides the next wave of direction for the market.

But the market is merely a trading proxy for risk, so outperformers/underperformers, correlations, and similar/different chart patterns between different securities and asset classes adds a lot of clarity to the current market as well as the trades that will work going forward.

A recent example-- the S&P 500 broke its 200d on Aug 11. That very day, EUR/USD sold off 300 pips, AUD/USD broke down through a rising wedge, cable broke its important 1.58 S/R level, the DX rallied off its 200d, and a variety of other securities broke out of developing patterns I'd been watching. All of the risk-on securities broke out of their patterns to the downside, which suggested risk was going to be offered from here as this was a defining break with multiple big moves out of well-defined developing chart patterns. That type of confluence is significant.

Momentum is created by the fact that the market is always right (from a money-making perspective, not as a discounting mechanism), but market participants also, as their job, need to be on the right side of the market, and this reflexivity amplifies and at times determines market moves. It's the bulls overcoming the bears or the bears overcoming the bulls. In a vacuum with no market, the "right" price always wins out as an un-interventionalist populace allows the natural supply & demand forces play out. With the advent of a market, the market participants not only determine price from natural supply & demand, but perception of others' supply & demand, as well as future supply & demand. The only way to gauge the market consensus and figure out the relevant theses being traded, which is the only way you can determine your opinion on which side of the argument is right and thus make a trading decision for profit, is if you inspect the charts.

Lots of bond bears are trading the US sovereign credit risk thesis because the US's debt/GDP is the relevant trading topic for them. That is just not what the market is watching, however, and they will not make any money until either that is what the markets begin watching or another totally different and irrelevant bear thesis is the new relevant argument going on in the market.

Sun, 08/29/2010 - 04:47 | 551022 Irwin Fletcher

If TA helps justify a trade, then it has predictive power. If it tells you a market's thesis, then it's somewhat predictive (but of course not deterministic), and that's a good thing. One issue is whether you can beat the algos to the trade. Another is whether you get information as quickly as GS. Your example seems informative and significant, but I'm captivated by your thesis that the market is always right. I read a lot about market manipulation here on ZH, and how the equities markets don't necessarily make sense on a fundamental economic basis. I get the sense that TA isn't always limited by economic reality or free market participants, and for that reason, it may have the potential to succeed where traditional analyses fail. The manipulators may exhibit patterns of their own that could be uncovered by the sufficiently clever. If the markets weren't manipulated, the implied correlation wasn't so high, and algorithms didn't drive the S&P, then the supply/demand argument makes sense. Maybe it still does to some degree, but I approach it with caution because the notion of 'what the market is watching' appears less relevant since 2008.

Sun, 08/29/2010 - 05:10 | 551028 naufalsanaullah

The predictive vs deterministic issue was a matter of diction. Sure, it isn't deterministic, sure it is predictive. You know what I mean(t).

Beating algos to the trade is irrelevant because algos have entirely different strategies than me and more importantly timeframe than me. The only algos that would affect me are predatory HFTs, but then again you can hear words of irritation and contempt at them even on the GS trading floor.

Speaking of GS, I do not engage in "information arbitrage" or buying the news. I buy my take on the news and my prediction of the news, I don't chase the herd, precisely because information dispersion is asymmetric and I have no edge in it.

The market is not efficient, at all, and is only a moderately good predictor of future economic activity. Being right or wrong about the future economic conditions are not nearly as important than being right or wrong about the market's perception of the future; after all, that determines price, which determines profit or loss.

Implied correlation is high, yes, but I use TA everyday as a part of my arsenal for judging whether it's going to be risk on or risk off.

I think people who use exclusively TA are little more than gambling and their risk and money management skills will be the biggest force behind their alpha generation. I trade more off of my macro fundamental theses, but charting is an indispensable tool for me for getting the holistic picture on what is moving and why.

Sun, 08/29/2010 - 02:31 | 550969 Mazarin

Liked this phrase: "the wrong thesis being liquidated and amplifying the move"

Sun, 08/29/2010 - 03:43 | 551000 dcb

Yeah, I posted the longer term trend line on this web site on s and p over a month ago and reposted the other day.

it is good charting work, and better than most of the people who post (although I have bias because I saw the same patterns)

on your third chart you can draw slightly different long term down trned lines from the market peak, it will show we have falled into the down channel trend line as if the lehman episode didn't happen.

you can to the same for tlt. (as once more) i stated on this web site.

Sun, 08/29/2010 - 05:50 | 551071 Buttcathead

875 aint gunna hold, my chart lines guess that "SPY" could sell for $25 in 2011-2012. Why? becuz folks is broke and they aint gots no money.

Sun, 08/29/2010 - 11:06 | 551248 banksterhater

Your outlook is for longer term(weeks) Who cares?

You will lose your ass betting on more than a week, or days. Nobody left in the market does. $33Bil pulled out by retail, foreign inflows to equities have dropped since April. It's all computers with no liquidity underneath if they don't play. All movement is based on political intervention and rumor, and this week is Wed ADP/Fri jobs, nobody is getting in front of this with serious ca$h.

I prefer using this guys charts- it's an ascending wedge, that's all that matters to me, to 1070 then likely breaks down.

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3779195

Sun, 08/29/2010 - 12:02 | 551310 FEDbuster