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Stocks on Verge of Meaningful Breakdown

|Includes:DIA, QQQ, SPDR S&P 500 Trust ETF (SPY)

The S&P 500 index closed sharply lower again today, moving slightly below support at the upper boundary of the previous trading range between 1,120 and 1,220. A subsequent close below current levels would confirm the break below congestion support in the 1,220 area.

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As expected, the move below the lower boundary of the symmetrical triangle that had been developing since the beginning of the month resulted in an acceleration of the decline.

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As an aside, this triangle pattern has been mentioned in mainstream financial media during the last several days, including the following “analysis” that appeared in a generic newswire story this morning.

The S&P 500 has formed a “triangle” pattern, a sign to analysts who study charts that the rally is about to resume after the benchmark gauge for U.S. stocks rose as much as 20 percent last month. The index’s trading range has narrowed since October, as the index stalled after rising to its average level over the past 200 days. Based on the size of this triangle pattern, the index may climb as high as 1,430, said … a technical market strategist …

“A triangle or a pennant formation forms during the middle part of a move, and typically these patterns resolve themselves in the direction of the preceding trend,” [the analyst] said in a telephone interview yesterday. “That would suggest that this is ‘the pause that refreshes’ before we get the next leg up.”

This analysis is either grossly incompetent or intentionally misleading, providing another excellent example of why self-reliance is so important. Based on this commentary, the uninitiated reader would believe that the short-term technical picture is unambiguously bullish, when nothing could be further from the truth. As always, every technical development only has meaning when viewed in its proper context. Let’s take a look at this particular symmetrical triangle in context.

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Following a measured, healthy move, a symmetrical triangle is usually a continuation pattern, suggesting that the previous trend is likely to reassert itself. However, the rally during October was an extreme, unsustainable advance. When a technical pattern denoting market indecision forms after an extreme move, there is no bias toward continuation and you simply have to wait for the formation to resolve. In this case, the breakdown today was a bearish signal that favors additional short-term weakness. The technical analyst who provided the commentary quoted above is either unaware of relatively elementary market behavior principles or was induced to provide a biased view. In either event, this type of misleading analysis, which appears throughout the mainstream financial media on a daily basis, underscores the needs to know your sources and recognize when you are being led astray. As we often note, one of the most important keys to long-term success as a market participant is self-reliance. The more you understand about market behavior, the less you will need to rely on market analysts like us and the better off you will be.

Returning to the short-term outlook, price behavior during the next several sessions could produce an important signal with respect to long-term direction, so it will be important to continue monitoring the stock market closely. We will identify the key developments as they occur in our market forecasts and signal notifications available to subscribers.

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Stocks: SPY, DIA, QQQ