Head and Shoulders Rorshach Test

Includes: DIA, QQQ, SPY
by: Vinny Catalano

In case you hadn't noticed, there’s a big head and shoulders debate brewing. A bona fide bulls versus bear story.

One side (the bulls) sees the stock market world from a decidedly more optimistic perspective with the potential of an upside breakout and a stock market run to new recovery highs. This view is exemplified by the first chart with the neckline somewhere around the 950 level (S&P 500).

Then there is the more pessimistic crowd who see the glass half empty with the threat of a downside break below the 880 level and the potential retest of the lows of early March (second chart above). The same price data, but seen from different time perspectives.

In both cases, old school market technicians will tell you nothing can be concluded UNTIL the pattern is complete, meaning that the neckline has to be broken and the ensuing move underway. It is most interesting that all this is occurring just as the markets enter the all-important earnings season and the fundamental justification for higher (or lower) prices, the answers to which we will receive in the coming weeks.

Investment Strategy Implications

Anyone who has read the technical analysis side of my work these past years knows that I am not a big chart pattern guy. No doubt there are those who have found a way of producing a better than 50/50 chance of predicting future price actions via chart pattern analysis, however, I am not one of them.

In my experience, the vast majority of chart patterns are like a Rorschach test – you see what you want to see. Frankly, the only consistent justification that I have found for paying any attention to chart patterns is the simple fact that many others pay attention to chart patterns, which then moves chart pattern analyses to the behavioral science realm – the study of your fellow investment rats and how they run the maze.

From the more bullish perspective (which is where I sit), the completion of a market bottom would be signaled by an upside break above the neckline. As I have written several times before, that would be the sign for the old school technical analysts to ring the bottom-has-been-seen bell. BUT, as noted above, that cannot/should not be done before the fact.

Or, to quote that investment sage, Yogi Berra, “It ain’t over ‘til it’s over.”