Big Reversal Patterns

Big Reversal Patterns

Courtesy of Springheel Jack

Over the last few months I’ve been posting a lot of very large reversal patterns on all kinds of indices and instruments including EEM (the emerging markets ETF), a swathe of individual overseas markets, copper, oil, and forex. I’ve also mentioned that we might see large reversal patterns form on key US equity markets. Now is a good time to have another look at that.

Reviewing the 7yr SPX chart, we can see that big reversals tend to be signaled by H&S patterns, with some double-tops and double-bottoms in the mix as well. I’ve marked most of these on the chart below, leaving out the double-top this year, the inverted H&S (IHS) in 2010, and the double-bottom in 2011 – due to space constraints. Each of these seven reversal patterns, except the H&S in 2010, made the pattern target after the pattern neckline was broken.

I mentioned after the June low that a double-top might be forming on SPX and that is the smaller double-top of two nested double-tops that may be forming there, each of which would trigger as a valid pattern only on a break below the neckline or valley low between the two tops.  The first double-top would have a target in the 1100 area for a test of the October low on a break below the June low. The second of the two tops could be made anywhere from the highs last week to the 1440 area.

I don’t know what will happen next – confirmation of a H&S pattern or a double top, or continued upside?  65% of potential double-tops never make it back to test the neckline or valley low. Only after they break below those do they become high-probability patterns.

Nevertheless, as we noted, earnings estimates appear too high, revenues seem to be stagnating, and P/E ratios are currently at the high end of their usual range. The ECB looks toothless again after Draghi’s fighting words last week. Consumers are still retrenching. The current high rate of US unemployment fails to account for part-time workers wanting full-time jobs, or for the under-employed.

The continuing commitment of the Fed to support markets with easy money makes the charts more bullish than they would be without Fed intervention. While the Fed’s current activities are providing stocks with some liquidity now, further large-scale Fed intervention seems unlikely without a precipitating event. (See Lee Adler’s liquidity indicator.)



We could see a bounce in the Euro (and relative decline in the Dollar) over the next few weeks, which tends to be good for US equities. However it also seems likely that Spain will ask for a bailout in September, which would again weaken the Euro. The ECB doesn’t have a credible plan of action. But as noted above, the eurozone’s loss may be the US’s gain, as money from the eurozone flows into the US markets.

From a technical perspective, there is downward pressure on the EURUSD with the H&S that broke down in late 2011 having made it halfway to its target in the 1.11 area. That target is at a very well-established long term support trendline from late 2004. H&S patterns are high-probability patterns and when they fail, it is generally either shortly after breaking the neckline, as with the H&S on SPX in 2010, or near the target, as with the H&S on the Russell 2000 in 2012.

Less often, we see a move just over halfway to target, and then failure. I’m expecting EURUSD to reach its 1.11 target, with a possible failure area at strong support in the 1.17-1.19 area. The fundamental outlook coincides with the technical bear setup on the Euro – making the 1.11 target more likely, in my opinion:



What would impress me on the bull side? The SPX pivot in the 1440 area is key. A break above that with confidence kills the larger possible double-top scenario and does serious damage to the smaller one. That break would set up a test of the 2007 highs. In a normal presidential election year, we would see a strong rally for the rest of the year.  A break above the 1440 SPX pivot would set the stage.  As always, time will tell.

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