August 17, 2010

By Elliott Wave International

In the August issue of his Elliott Wave Theorist, market forecaster Robert Prechter alerted readers that the U.S. stock market was slicing the neckline of a classic head-and-shoulders pattern in technical analysis, and that this may send the market into critical condition.

Prechter said that when the Elliott wave count and a head-and-shoulders pattern are saying the same thing about the stock market, it’s best to pay attention.

Read some of the latest nuggets directly from Robert Prechter’s desk — FREE. Click here to download a free report packed with recent quotes directly from Prechter’s Elliott Wave Theorist.

Here’s how the August issue of the Elliott Wave Financial Forecast, the sister publication to Prechter’s Theorist, described the head and shoulders pattern unfolding in the stock market:

“The weekly Dow chart [below] shows the development of an intermediate-term, head-and-shoulders pattern from the January high at 10,729.90 to the present. The January high marks the left shoulder, the April 26 high at 11,258 is the head, and the right shoulder is now ending. The April [Theorist] discussed the pertinent characteristics that Edwards and Magee used to define this technical pattern … all apply to the current formation. Observe how weekly stock trading volume has contracted during the development of the right shoulder, a necessary trait of this pattern. The downward-sloping neckline — exactly as on the big ten year pattern — displays market weakness, which is consistent with our interpretation of the wave structure.”

This chart shows the head-and-shoulders pattern.

"Generally, when the neckline slopes downward, the right shoulder does not rise to the level of the left shoulder ..."

Here’s what Robert Prechter himself said in a recent Elliott Wave Theorist:

“Generally, when the neckline slopes downward, the right shoulder does not rise to the level of the left shoulder …”

Please look at the chart again — then re-read Prechter’s quote.

Read some of the latest nuggets directly from Robert Prechter’s desk — FREE. Click here to download a free report packed with recent quotes from Prechter’s Elliott Wave Theorist.

This article was syndicated by Elliott Wave International and was originally published under the headline Slicing the Neckline: When the Market May Go into “Critical Condition”. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

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In my post last week on Dollar Index revealed Weakness, I was anticipating a possible downturn of the Dollar Index. Yet last week’s Price Action has invalidated the Head and Shoulder chart Pattern on the 4 Hourly chart .

In fact, the chart pattern has now evolved to a possible Double Top formation on the daily chart, which again signals to a possible bearish reversal for the Dollar Index.

Dollar Index Daily Chart

What interests me is the second top formation seems to have a head and shoulder pattern too, with the right shoulder in the midst of forming. This again enhances the bearish view.

On a shorter term, looking at the 4 hourly chart below.

4 Hourly Chart of Dollar Index

4 Hourly chart of Gold seems to suggest a pending Head and Shoulders chart pattern, which could hint towards a bearish reversal.

4 Hourly Chart of Gold

We are currently near on the high of the Right Shoulder, should it complete its formation, this could mean that Gold could fall beyond 1100 level.

The current Price level is also near to Week 18 high, which could be a resistance level. The resistance zone is emphasized by a confluence of an equidistant channel with the horizontal resistance level.

However, the bearish view will be invalidated if Price attempts to break beyond the high of the Head formation.

A follow up on last week post on USDX: Dollar Challenging Previous Highs and Near Term Weakness Seen

We mentioned that the Dollar Index may face a possible resistance, and it was shown on the Daily chart by the Bearish Engulfing Candlestick pattern.

Daily Chart of Dollar Index

This was also confirmed in the lower timeframe on the 4 hourly chart.

4 Hourly Chart of Dollar Index

As seen from 4 hourly chart, a Head and Shoulders chart pattern has just completed. In addition, the current Price Action attempts to to test the neckline, which is likely to be an opportunity for late Bears.

However, this bearish reversal may be invalidated if Price will break above the neckline, testing the top of the Right Shoulder.

Thus, in the near term USDX may find support on the weekly trendline (Green) if the Bulls are aggressive to continue their rally, otherwise, the next monthly support (Red) should be strong to hold its bullish fort.

The USDJPY made a small move into a higher trading zone. Foremost question in mind is whether it is likely to stay. On the other hand, a trendline on the weekly chart suggest that momentum of fall has indeed slowed. There might even be a sign of potential reversal.

1-year range for USDJPY

W-shape for USDJPY

An inverted ‘Head and Shoulder’ has emerged. Confirmation is required now.

Breaking the neckline is now critical

It is possible for traders to take a week-by-week view and do fairly good job at trading. The 4-hour chart is a good place to this and in the case of AUDUSD, 2 pieces of information jump out.

First a ‘Head and Shoulder’ pattern should be easy to see. This one is obvious so no need to check with your neighbor. Since the neckline is also broken, only a bear trap now can reverse the fortune of the Aussie. Secondly, we can see a series of lower highs and low lows.

Therefore there is only one way to go: sell resistance and take profit at support.

Few questions to ask now.

1. Quick look at February levels – Feb high has been violated so no support there.
2. Price is extended so its hard to short now (where to put the stop?). Let’s wait for a pull back.

Since that’s the case, any early week pullback will create the precedent for a mid- or late week re-test of level may see big move when everyone is convinced.

I hope every thing will fit perfectly.

By the way, some students told me my short bias was 2 weeks too early. I am glad I wasn’t 2 months too early or 2 months too late.

Today, we have a detailed analysis of Swiss Franc for a possible swing trade using Multiple Time Frame Analysis.  We shall look at 2 timeframes, the daily and 4-hourly for our study.

On a daily chart of Swiss Franc (USD/CHF), it seems that there is a long term up trend within an equi-distant channel.

The recent pull back was stopped at a support / resistance line with a doji, hinting to a possible up swing move.

Daily Chart of USDCHF

On 4 hourly chart, there is an equi-distant channel for the down move.

The down channel seems to be ended by an inverted Head and Shoulder pattern, which also hints to a possible bullish reversal.

4 Hourly Chart of USD/CHF

Finally, with the bullish setup, it is necessary to know that there are 2 resistance levels that the Bears will be look to short USDCHF – the neckline of the inverted Head and Shoulders and the upper limit of the downward equi-distant channel.

The cautious Bulls, on the other hand, will be waiting for the completion of the inverted Head and Shoulders for a safer entry.

The USDJPY is printing a potential wedge on the day chart as well as inverted head and shoulder in the 4-hour. It is critical to confirm with break of neckline or breakout of wedge.

Potential reversal patterns for USDJPY

Today, we shall excite ourselves by looking at one of the most volatile currency pairs, GBP/JPY, which has a daily average fluctuation of about 300 pips.

In addition, we shall see how 3 chart patterns that is very evident on GBP/JPY for trend reversal and trend continuation – namely, rising wedge pattern, pennant and  symmetrical triangle pattern.

GBPJPY Weekly Chart with Chart Patterns

As shown on the chart above, the Bearish Trend Reversal started with the rising wedge formation, which later evolves into the famous Head and Shoulder pattern hinting towards a big bearish reversal move underway.

Afterwhich, every subsequent retracement of the downtrend has either a rising wedge pattern or a bear pennant pattern.

Thus, it goes to show that there is a high reliability of trend continuation when either patterns had formed.

As we observed the recent months, that there is a big rising wedge formation which seems to be forming since 2009, and a symmetrical triangle forming shortly.

As price draws nearer to the apex of the symmetrical triangle, a breakout is inevitable. Yet, will it be a another trend continuation or a bullish reversal?

Should it break out of the pattern to the bullish side, then more bullish sentiment will be added to the equation as many traders will be eyeing for trading the breakout.

Likewise for the breakout to the bearish side, whereby more shorts will be added too.

Whichever the breakout is to be, it will likely to be a big move, so it is worth keeping tabs with this volatile pair in the coming future.

Chart patterns are commonly found for almost any price charts. It is more visual when view using a line chart than candlesticks or price bar chart.

As each price bar forms, it may give the chartist a perspective in relation to the formations showed by the historical bars.

Today, we shall dissect a 4 Hourly chart of CHFJPY to understand how patterns can form and perhaps to take advantage of the formations for trading.

As shown above,  it is evident that CHFJPY has finished a Head and Shoulders Pattern which is a Bearish Reversal of the previous Up trend. The Up trend happens to be at the ‘armpit’ of the Left Shoulder and Price break down the trendline, indicating the Head is formed. With the falling price, buyers wanted for an entry and attempted to push the price higher, thus forming a pullback.

But it goes to show that more are keen to sell than buy, and after several attempts to break above the up trend line, there is a sharp plunge which is forming the Right Shoulder.

On the same chart with the Head and Shoulders pattern, the keener eye might find more patterns within the Head and Shoulders!

1. Left Shoulder was a Double Top formation and Price found a support line to bounce off and overcome the top of the Left Shoulder to form a Higher High (Head).
2. After the attempt to make the Higher High, a bearish engulfing candlestick pattern formed resulting a possible price fall as seen on the chart.
3. A support / resistance line provide another bounce back with price forming a rising wedge pattern, it also an attempt to test the up trendline and to break it to the bullish side. Along with the evening star candlestick formation, the bearish reversal was like a quick runaway to sell down CHFJPY.
4. After a break below the support line, it seem to consolidate and wanted to move up above the support line, yet, the failed attempt results another dive for CHFJPY.

It is easy when we analysis charts in hindsight, when the formations were already there. It is a challenge for us to make sense of the charts as the days goes by. But after knowing a possible formation is underway, you can be sure many chartists who see it will want to ride it.

What we see for CHFJPY is on a 4 Hourly chart, which the above patterns were forming as the weeks goes by. It also shows that when the bullish sentiments of the Big Boys faded, the bearish reversal can last for a long time before another big move comes.

In previous postings, we discussed the elements of a good signal. This week we see such a combination unfold before us in the EURYEN. Lets recall.

A good signal has the following:

1. Resistance level provides a ‘hard’ place for price to reverse
2. A chart pattern hints at reversal
3. At the critical point, a candlestick pattern can be seen
4. All of the above come together in a confluence ultimately confirmed with trend line break

Let’s good at the EURYEN chart.

Firstly, the daily chart provides the ‘hard’ place to start looking for a reversal.

Daily resistance hints at reversal

At the 4-hour chart, we can other elements fall in place.

• The violation of the first trend line shows the end of the predominant trend
• A price pullback after the first trend line break hints now a head and shoulder pattern
• A second (shorter) trend line can be drawn to indicate the trend of the pull back
• A big evening doji look-alike bar that violates the second trend line shows the breakdown of the pullback
• Finally the violation of the neckline confirms the head and shoulder formation

Head and shoulder in EURYEN at resistance

Some previous postings

Elements of a trade signal

Reversal signal also shown in Loonie

The charts show a potential reversal of fortune in the EURUSD and USDJPY.

The USDJPY hourly chart plots a double top that has broken its horizontal support. While this is traditionally a reversal chart pattern, confirmation has to come from another chart – the 240min. In this case, an upward trending support is clearly visible and this has not been violated.

A double top in the hourly chart shows resistance over 2 days whereas a trendline in the 4-hourly chart is a multi-week support.

Double top in the hourly chart

As for the Euro, a potential head and shoulder patten is now clearly visible awaiting confirmation by breaking the neckline. A break and throwback play is now the prudent strategy.

Inverted head and shoulder awaiting confirmation

If both reversals materialise, we are looking at a retracement move in the Dollar.

The Aussie completed a Head and Shoulder pattern and broke its neckline before Christmas. Now it is making a pullback move to test resistance. If the neckline makes a successful resistance, the H & S pattern will remain intact and its validity as a reversal pattern is confirmed. If the neckline is defied, there is a chance that the initial neckline break may be a bear trap and that Aussie will resume an uptrending move.

Aussie making pullback to test resistance of neckline

Chart patterns provide a good way to figure out the direction of the market. A good chart pattern offers the following clues to the trader:

• Hint of market direction
• Criteria for confirmation
• Early trade signal

All in all, its qualities are predictive, pre-emptive.

Let’s look at Aussie this 2 weeks to see if clues were left for traders.

From left to right:

1. Week 49 printed a ‘Head and Shoulder’ formation (solid blue line); this is a strong hint of a bearish reversal.
2. Neckline (A) provided the confirmation of the H & S formation which acted as a pullback resistance at point (1).
3. By Friday 04 December, a more obvious H & S formation was formed with the adoption of the dotted dark blue line;  confirmation provided by neckline (B).
4. Tuesday and Wednesday of Week 50 printed a Double Bottom formation; confirmation came on Thursday with the break of the horizontal resistance (C).
5. Rather than play ‘breakout’, point (3) was a very good throwback level to go long at support.

What to look out for next week?

A horizontal channel reveals levels support at [E] that has broken on the down side. So the opening move of Week 51 could be a test of resistance at [E] and support at [F]. Price takes the path of least resistance so the integrity of both levels may provide clues for the middle of the week to come.

Aussie Dollar chart patterns

Big moves in the major pairs and crosses were made between Thursday and Friday (26 – 27 Nov 2009). This is a worthy incident to look at and learn from. Lets recall the incident:

• The pairs involved made moves that exceeded their usual daily range
• They show a sudden return of risk aversion
• The Japanese finance minister used the word ‘abnormal’ to describe the market
• Analysts quickly associated the move with stock market sell-off in Dubai; some said it is a blip while others say it ‘has legs’

From a technical point, there are signs of a risk aversion move in currencies prior to the sell-off but the charts also show confusion.

Let’s look at the GBPUSD.

1. A fall in the GBPUSD is a risk aversion move
2. Sterling was resisted by a 6-month level at around 1.67~
3. From the day chart we can see at least two failed attempts to break out
4. By Thursday 26 November 2009, GBPUSD was resisted and suggested a right shoulder of a Head and Shoulder chart pattern
5. The Head and Shoulder chart pattern is usually read by chartists as a reversal pattern
6. This chart pattern can be clearly read in the 4-hour chart
7. By Friday, price has fallen through the ‘neckline’ on the 4-hour chart; falling below the neckline is a confirmation of the validity of the pattern
8. However a long tailed doji or ‘hammer’ look-alike candlestick quickly reversed the move and the neckline was unable to serve as resistance
9. The day chart shows what looks like a failed break

In other words, was there a true panic and reversal? Has this been replaced by regret and remorse?

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CNBC 27 Nov 2009 – Dubai Debt Woes ‘A Blip’, Won’t Lead to Global Fallout: Strategist

CNBC 27 Nov 2009 – Dubai Stock Market Fear Has ‘Legs’: Dennis Gartman

Marketwatch 26 Nov 2009 – Japan finance minister: forex moves ‘abnormal’

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Strong resistance for Sterling

Was this a breakout? Is it a bear trap?