Which direction for the U.S. Markets? We can look to many sources for inspiration to help us form an opinion as to whether we should stay invested or move to cash during this period of uncertainty. After all the market has not performed to well in the first four weeks of this year.
Since the new year we have seen the formation of what we stock market technical analyst’s call a continuation pattern on the S&P500 Index. A similar pattern is forming in the Dow Jones 30 and the Dow Jones Industrial Index. But what can it tell us about the future market direction?
Technical analysts refer to chart patterns and those patterns usually take the shape of:
- Reversals – the pattern suggests that the current market direction will change – from up to down or down to up – Double Bottom, Triple Bottom, Cups & Saucer
- Continuation Patterns – suggest that the market is taking a break from the current primary trend before it continues on – lateral consolidations or triangles and flags.
The are a number of continuation patterns, in this article we will look at the “Flag” and the “Triangle”.
Take a look at the S&P 500 chart below.
The major points to note:
- A. In early 2013 the market direction was up
- B. Here we saw the market retreat in a uniform way, this is referred to as a Flag formation, this is a continuation pattern that suggests the market will continue in the direction of the previous trend (see point A)
- C. The market does indeed continue up
- D: After a significant decline in October 2014, the market reverses on a single bottom and moves up
- E: Here we see the formation of a Symmetric Triangle, it is almost a descending triangle, but the outcome is expected to be the same – a continuation of the previous trend (point D)
- F. The expected outcome of the completion of the triangle is UP
Now here is the dilemma, will it go UP or will it go DOWN. I have extended the trendlines to indicate we will see the resolution of this pattern in February.
Even the much espoused chart patterns are not 100% infallible, meaning they are not 100% correct every time. There are a whole host of factors that can impact the direction of a stock at any point in time, political or economic. The reason there are two arrows one pointing up and one pointing down is to indicate that it could potentially go both ways.
The direction the price trend breaks out of the triangle will usually indicate the direction of the next phase of market direction. Probably UP but it could be DOWN.
The market is actually at an excellent price point to invest as it is at the bottom of the triangle base. It is on its third bounce off the bottom of the triangle.
This might sound like witchcraft, but market patterns are established to help us make sense of the supply and demand battle that goes on in the market place. Many people do not understand this. For example the bottom of the triangle indicates the price at which the bulls decide the market is at a good place to invest money. The top of the triangle indicate that the resolve of the bulls is overpowered by the selling power of the bears that think it is a good time to sell.
Ultimately the battle of the triangle is won buy either the Bulls or the Bears
- The Bears that push the bulls through the floor of the triangle starting a downtrend
- The Bulls that push the bears through the roof of the triangle starting another uptrend
Now is probably a reasonable time to take a bet on the upside – but ultimately it is resolved by the breakout direction of the triangle.
May the trend be with you.