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Déjà vu All Over Again!/ Brandon Wendell: Online Trading Academy Senior Instructor

I am writing this after just having arrived in Dubai to teach another class. While I was unpacking, I was watching CNBC - I know, bad habit. It was interesting as they had Nassim Taleb, the author of Black Swan, as a guest. He refused to discuss the events of the 1000 point Dow drop as he was advising one of the funds possibly mixed up at the center of the controversial trading of that day. However, he did make an interesting comment. Mr. Taleb said that he took a hiatus from the media but now that he is back, the world economic situation seems worse than when he left!

The major issue he cited was the conversion of private debt to public debt as the world's governments attempt to bail out their respective economies. The heart of the issue is not just Greece's debt, but all of Europe and also the United States. I alluded to this being an issue in my last article and figured it is only fitting as I am seeing technical patterns that suggest a major stock market collapse may be on the horizon.

Many of you know that I enjoy trading technical patterns on the charts. They seem to work, except when they don't, because they are demonstrating the trading and investing sentiment of the people who are trading the markets. I think all of you can agree with me when I say the markets are insane. Well the definition of insanity in this instance is doing the same thing over and over again and expecting a different result.

Last week, I wrote in my article "When PIIGS Fly," about the diamond pattern that the S&P 500 chart was showing. As you can see from the chart pictures that were in that article, I wrote the article before the major movements of that Thursday in the markets. That is one of the major benefits for students participating in the Online Trading Academy's Extended Learning Track (XLT) program; the students heard that information in time to act upon it rather than reading about it later.

Well, there is another chart pattern that is eerily similar to one that started the 2008 recession. If you refer to the chart, you will see that the weekly chart of the S&P 500 showed a large head and shoulders reversal pattern prior to the collapse. My students in the New York and Orlando offices in late 2007 will remember this as we discussed it in class as it was occurring.

Figure 1

Note how the market warned of weakness during the uptrend by having several down weeks that produced large red candles prior to the collapse of equity prices. In an uptrend, there should not be large selling candles present. If there is, it is referred to as price shock and usually precedes a trend reversal.

Flash forward to our current market rally. Many of the pundits on CNBC are calling last week's drastic drop as a buying opportunity in a bullish market. However, to the trained eye, this looks like price shock. I'll even go a step further and say that we have formed the left shoulder and head of a possible head and shoulders reversal pattern. If this pattern follows through, we could be looking at what many will call a double-dip recession.

Figure 2

There is plenty of economic and fundamental data that are showing cracks in the strength we have experienced since the market lows in March 2009. I also would like to point out some technical data that concerns me as well. The market loves symmetry. There are amazing parallels between prior price patterns and current ones. Any of you who have attended John O'Donnell's Globalization talks are well aware of striking similarities between the 1929 crash, the Japanese recession, and the 2008 crash. Symmetry in the patterns comes with both price movement and time. Look at the inverted head and shoulders that ended both the 2001 tech bubble burst and the 2008 credit bubble burst.

Figure 3

Now let's look at the 2007 head and shoulders and compare it to the current price pattern that I am seeing developing in the equity markets. The time between the left shoulder and the head in 2007 was 13 weeks. The current pattern has 14 weeks between the two. In 2007, the overall distance between the two shoulders was 21 weeks. If a similar time pattern holds for this head and shoulders, we should see price peak in mid-June, most likely about the week of the 11th.

Figure 4

The pattern should break the neckline sometime in early August. The measured move for the pattern is taking the distance from the neckline to the top of the head and extending it downward from the break of the neckline on the right shoulder. This gives a price target of 1029 on the S&P 500. Keep in mind that the measurement is not exact and you should always defer to demand levels for price targets when trading.

Figure 5

As a trader, I am always aware of the risks involved in any position I take. I also want to know what conditions would negate the trade or the pattern that I am planning. By doing this before I enter a trade, I am less likely to ignore the warnings of failure. Trying to analyze these dangers after entering is risky as no traders want to be wrong, and we will rationalize or ignore danger signs in hopes we will end up being proven right. That being said, for the pattern to work, the right shoulder should be lower than the left. This shows that there is weakness in the markets. The right shoulder doesn't have to be lower in price. It just has to peak closer to the neckline than the left shoulder did. Since the current left shoulder peaked 101.54 points from the neckline, a break of 1219.80 by the S&P 500 would cancel the pattern since the right shoulder cannot exceed the head.

Figure 6

Now you have an idea as to what I am expecting for the next few months in the market. Only time will tell if this pattern will follow through. In any event, traders and investors should be looking to reduce risk in the markets. This can be done in many ways: Reducing share size, intraday trading only, setting tighter stops, and even protection with hedges or options. If you don't know how to do this, I suggest you talk to an Education Counselor at your local Online Trading Academy office and see which educational program will best prepare you for the upcoming markets. Until next week, trade safe and trade smart!

On a lighter note….Having a little fun at the San Diego Wild Animal Park. Does this make me a Turtle Trader?

Figure 7

- Brandon Wendell

Disclosure: Long goog and Short yhoo